Modeling the Equity Factor Zoo to Near Death

Which equity factors truly explain stock returns, and what group of them constitute the best model? In their November 2019 paper entitled “Bayesian Solutions for the Factor Zoo: We Just Ran Two Quadrillion Models”, Svetlana Bryzgalova, Jiantao Huang and Christian Julliard present a Bayesian estimation and model selection method for pricing of stock portfolios that allows simultaneous examination of the entire zoo of equity factors. They apply the method to 51 factors described in past papers, yielding a total of 2.25 quadrillion factor models of U.S. stock returns. They test abilities of these factors and models to price 25 portfolios of stocks sorted by market capitalization (size) and book-to-market ratio (value) and 30 industry portfolios. Using returns for factors available monthly during January 1970 through December 2017 and for factors available only quarterly during first quarter 1952 through third quarter 2017, and contemporaneous test portfolio returns, they find that: (more…)