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The Low-Minus-High Portfolio and the Factor Zoo

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  • Cujean, Julien
  • Andrei, Daniel
  • Fournier, Mathieu

Abstract

Regardless of whether the CAPM is rejected for valid reasons or by mistake, a single long-short portfolio will always explain, together with the market, 100% of the cross-sectional variation in returns. Yet, this portfolio, which we coin the “Low-Minus-High (LMH) portfolio,†need not proxy for fundamental risk. We show theoretically how factors based on valuation ratios (e.g, book-to-market), or on investment rates, can be proxies for the LMH portfolio. More generally, the empiricist can uncover an infinity of proxies for the LMH portfolio, thus unleashing the factor zoo.

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  • Cujean, Julien & Andrei, Daniel & Fournier, Mathieu, 2019. "The Low-Minus-High Portfolio and the Factor Zoo," CEPR Discussion Papers 14153, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:14153
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    2. Calvet, Laurent E. & Betermier, Sebastien & Jo, Evan, 2019. "A Supply and Demand Approach to Equity Pricing," CEPR Discussion Papers 13974, C.E.P.R. Discussion Papers.

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