RFS Advance Access originally published online on October 20, 2009
Review of Financial Studies 2009 22(12):5133-5174; doi:10.1093/rfs/hhp065
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Basis Assets
School of Economics, Seoul National University
Kenan-Flagler Business School, University of North Carolina
Stephen M. Ross School of Business, University of Michigan
Send correspondence to Jennifer Conrad, CB#3490, McColl Building, University of North Carolina-Chapel Hill, Chapel Hill, NC 27599-3490; telephone: 919-962-3132; fax: 919-962-2068. E-mail: j_conrad{at}unc.edu.
JEL Classification: C10, G11
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Abstract |
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This paper proposes a new method of forming basis assets. We use return correlations to sort securities into portfolios and compare the inferences drawn from this set of basis assets with those drawn from other benchmark portfolios. The proposed set of portfolios appears capable of generating measures of risk–return trade-off that are estimated with a lower error. In tests of asset pricing models, we find that the returns of these portfolios are significantly and positively related to both CAPM and Consumption CAPM risk measures, and there are significant components of these returns that are not captured by the three-factor model.
We thank Michael Brandt and Wayne Ferson and two anonymous referees for helpful comments, as well as seminar participants at the 2004 American Finance Association Meetings (San Diego, CA), Arizona State University, Baruch College, Case-Western Reserve, Federal Reserve Bank of Chicago, DePaul University, Harvard University, the Joint University of Alberta/University of Calgary Conference, London Business School, London School of Economics, Texas A&M, UCLA, the University of North Carolina, University of Oregon, University of Washington, the 2005 Utah Winter Finance Conference, and Vanderbilt University for helpful comments and suggestions. Portfolio data used in this paper are available at http://webuser.bus.umich.edu/rdittmar by following the "Research" link. The usual disclaimer applies.