The Finance Brown Bag Seminar is held by the Institute for Finance, Banking and Insurance (WU Vienna) and the Vienna Graduate School of Finance (VGSF). It serves as a presentation platform for PhD students, faculty members, and visitors. An overview of BBS on the website of the Institute for Finance, Banking and Insurance.
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Lukas Körber, Goethe University Frankfurt
Nonlinearities and Pricing Complexity in the Cross-Section of Stock Returns
joint with Fabio Girardi (Vienna University of Economics and Business) and Christian Schlag (Goethe University Frankfurt)
We evaluate the pricing performance of a robust stochastic discount factor spanned by a broad cross-section of factor returns. Methodologically, we combine kernel principal component analysis—which extracts factors as nonlinear functions of a high-dimensional set of firm characteristics—with novel regularization techniques. Allowing for nonlinearities enhances the model’s performance in explaining a wide range of prominent cross-sectional stock-return anomalies and reduces pricing errors. We further decompose the mean–variance efficient portfolio into linear and nonlinear components and study their relative contributions across macro-financial conditions. Out-of-sample, incorporating nonlinearities increases theSharpe ratio of the mean–variance efficient portfolio by roughly 25% to 2.15.
