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Characteristic-Sorted Portfolios: Estimation and Inference

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  • Matias D. Cattaneo
  • Richard K. Crump
  • Max H. Farrell
  • Ernst Schaumburg

Abstract

Portfolio sorting is ubiquitous in the empirical finance literature, where it has been widely used to identify pricing anomalies. Despite its popularity, little attention has been paid to the statistical properties of the procedure. We develop a general framework for portfolio sorting by casting it as a nonparametric estimator. We present valid asymptotic inference methods, and a valid mean square error expansion of the estimator leading to an optimal choice for the number of portfolios. In practical settings, the optimal choice may be much larger than standard choices of five or ten. To illustrate the relevance of our results, we revisit the size and momentum anomalies.

Suggested Citation

  • Matias D. Cattaneo & Richard K. Crump & Max H. Farrell & Ernst Schaumburg, 2016. "Characteristic-Sorted Portfolios: Estimation and Inference," Staff Reports 788, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:788
    Note: Revised October 2016.
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    Cited by:

    1. Joachim Freyberger & Andreas Neuhierl & Michael Weber & Michael Weber, 2018. "Dissecting Characteristics Nonparametrically," CESifo Working Paper Series 7187, CESifo.
    2. Joachim Freyberger & Andreas Neuhierl & Michael Weber & Michael Weber, 2017. "Dissecting Characteristics Nonparametrically," CESifo Working Paper Series 6391, CESifo.
    3. Joachim Freyberger & Andreas Neuhierl & Michael Weber, 2020. "Dissecting Characteristics Nonparametrically," Review of Financial Studies, Society for Financial Studies, vol. 33(5), pages 2326-2377.
    4. Matias D. Cattaneo & Max H. Farrell & Yingjie Feng, 2018. "Large Sample Properties of Partitioning-Based Series Estimators," Papers 1804.04916, arXiv.org, revised Jun 2019.

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    More about this item

    Keywords

    portfolio sorts; nonparametric estimation; partitioning; tuning parameter selection;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General

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