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A Dynamic Model of Characteristic‐Based Return Predictability

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  • AYDOĞAN ALTI
  • SHERIDAN TITMAN
Abstract
We present a dynamic model that links characteristic‐based return predictability to systematic factors that determine the evolution of firm fundamentals. In the model, an economy‐wide disruption process reallocates profits from existing businesses to new projects and thus generates a source of systematic risk for portfolios of firms sorted on value, profitability, and asset growth. If investors are overconfident about their ability to evaluate the disruption climate, these characteristic‐sorted portfolios exhibit persistent mispricing. The model generates predictions about the conditional predictability of characteristic‐sorted portfolio returns and illustrates how return persistence increases the likelihood of observing characteristic‐based anomalies.

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  • Aydoğan Alti & Sheridan Titman, 2019. "A Dynamic Model of Characteristic‐Based Return Predictability," Journal of Finance, American Finance Association, vol. 74(6), pages 3187-3216, December.
    • Handle: RePEc:bla:jfinan:v:74:y:2019:i:6:p:3187-3216
    DOI: 10.1111/jofi.12839
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    Cited by:

    1. Peress, Joël & Dong, Xi & KANG, NAMHO, 2020. "Fast and Slow Arbitrage: Fund Flows and Mispricing in the Frequency Domain," CEPR Discussion Papers 15235, C.E.P.R. Discussion Papers.
    2. Valentin Haddad & Serhiy Kozak & Shrihari Santosh & Stijn Van Nieuwerburgh, 2020. "Factor Timing," The Review of Financial Studies, Society for Financial Studies, vol. 33(5), pages 1980-2018.
    3. Guillaume Coqueret, 2022. "Characteristics-driven returns in equilibrium," Papers 2203.07865, arXiv.org.
    4. Blanco, Ivan & De Jesus, Miguel & Remesal, Alvaro, 2023. "Overlapping momentum portfolios," Journal of Empirical Finance, Elsevier, vol. 72(C), pages 1-22.
    5. Dawen Yan & Xiaohui Zhang & Mingzheng Wang, 2021. "A robust bank asset allocation model integrating credit-rating migration risk and capital adequacy ratio regulations," Annals of Operations Research, Springer, vol. 299(1), pages 659-710, April.

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