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Time-variation, multiple testing, and the factor zoo

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  • Smith, Simon C.

Abstract

Bayesians circumvent the need for significance threshold correction when multiple testing and we recommend controlling the Type-S (sign), rather than the Type-1, error rate because it yields more reliable frequency properties for inferences. Our unified Bayesian framework, with theory-informed priors, identifies two breaks (2001 and 2008) in our 1980–2018 sample period. After each break the set of characteristics changes, and only market beta is selected in all regimes. In a portfolio application, the method generates significantly larger Sharpe ratios after transaction costs than a range of benchmark methods, including the same model that uses a Type-1 (not Type-S) error framework.

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  • Smith, Simon C., 2022. "Time-variation, multiple testing, and the factor zoo," International Review of Financial Analysis, Elsevier, vol. 84(C).
    • Handle: RePEc:eee:finana:v:84:y:2022:i:c:s1057521922003441
    DOI: 10.1016/j.irfa.2022.102394
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    More about this item

    Keywords

    Cross-section of expected returns; Firm characteristics; Type-1 errors; Type-S errors; Type-M errors; Multiple testing; Bayesian inference; Time-variation;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General

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