Edwin J Elton, Martin J Gruber, Christopher R Blake
ABSTRACT
A great deal of the literature in financial economics contains the
assumption that returns are a linear function of a set of observable factors.
The specification of the variables in the linear process (known as the
return-generating process) is one of the key issues in finance today. The
return-generating process is an important building block in asset pricing
models, portfolio optimization models, mutual fund evaluation, and event
studies. For many purposes (such as in developing asset pricing models
and evaluationg mutual fund performance), it is important to separate systematic
from non-systematic factors. There have been numerous attempts to examine
the number and type of systematic factors in equity returns. The purpose
of this study is to determine the systematic factors by examining mutual
fund returns. One important implication of modern portfolio theory is that,
given a belief about systematic factors, an investor should select an exposure
(beta) to each factor, a level of expected risk-adjusted return (alpha)
and a level of residual risk (residual variance). The mutual fund industry
has an incentive to offer an array of exposures to systematic factors in
order to meet investors' differing objective functions. Therefore, mutual
funds provide a logical way to obtain portfolios which have spread on the
characteristics of interest while smothering much of the noise inherent
when a model is fitted to individual security returns
Subject: Investment Factor Models (Empirical)
Elton: (212) 998-0361 eelton@stern.nyu.edu
Gruber: (212) 998-0333 mgruber@stern.nyu.edu
Blake: (201) 694-3483
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