Comparing Factor Models with Price-Impact Costs

Li, S, DeMiguel, V and Martin-Utrera, A (2024) Comparing Factor Models with Price-Impact Costs. Journal of Financial Economics. ISSN 0304-405X (In Press)

Abstract

We propose a formal statistical test to compare asset-pricing models in the presence of price impact. In contrast to the case without trading costs, we show that in the presence of price-impact costs different models may be best at spanning the investment opportunities of different investors depending on their absolute risk aversion. Empirically, we find that the five-factor model of Hou et al. (2021), the six-factor model of Fama and French (2018) with cash-based operating profitability, and a high-dimensional model are best at spanning the investment opportunities of investors with high, medium, and low absolute risk aversion, respectively.