US efficient factors in a Bayesian model scan framework

Abstract

PurposeThe author examines the impact these efficient factors have on factor model comparison tests in US returns using the Bayesian model scan approach of Chib et al. (2020), and Chib et al.(2022).Design/methodology/approachEhsani and Linnainmaa (2022) show that time-series efficient investment factors in US stock returns span and earn 40% higher Sharpe ratios than the original factors.FindingsThe author shows that the optimal asset pricing model is an eight-factor model which contains efficient versions of the market factor, value factor (HML) and long-horizon behavioral factor (FIN). The findings show that efficient factors enhance the performance of US factor model performance. The top performing asset pricing model does not change in recent data.Originality/valueThe author is the only one to examine if the efficient factors developed by Ehsani and Linnainmaa (2022) have an impact on model comparison tests in US stock returns.