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Anomalies Can Mean Alpha

Since the development of the capital asset pricing model (CAPM) about 50 years ago, academic researchers have documented several hundred “anomalies” that generate a significant positive alpha. There are now so many that professor John Cochrane referred to them as the “factor zoo.”

There are certainly large incentives to find these anomalies, both for academics and investment firms. And that raises the concern that many of the discovered anomalies could be nothing more than the result of data mining exercises. These concerns can be mitigated by out-of-sample tests, as well as strong risk or behavioral explanations.

An additional concern is that many academic research papers identify theoretical anomalies, meaning they might exist only on paper. However, it’s really an anomaly only if you can exploit it after considering real world transactions costs.

Read the rest of the article on ETF.com.

 

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