What is missing in asset-pricing factor models
This seminar is hosted by Adam Golinski
Abstract: Our objective is to price the cross section of asset returns. Despite considering hundreds of systematic risk factors (``factor zoo''), factor models still have a sizable pricing error. A limitation of these models is that returns compensate only for systematic risk. We allow compensation also for unsystematic risk. The resulting stochastic discount factor (SDF) prices the cross section of stock returns exactly, resolving the factor zoo. Empirically, about 70\% variation of this SDF is explained by its unsystematic risk component, which is correlated with strategies reflecting market frictions and behavioral biases.