Using 1964–2023 data for the largest 1,000 US stocks, this study analyzes nonlinear return-to-characteristic relationships for five factors: value, momentum, small size, low beta, and profitability. Larger information ratios are a key finding.
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Abstract
We examine nonlinear return-to characteristic relationships for five equity market factors: value, momentum, small size, low beta, and profitability. Our study employs monthly returns and characteristics for the largest one thousand US stocks from 1964 to 2023 with a focus on average active returns over the last 20 years. Beyond simplicity in modeling the return-generating process, we find no reason to assume a linear relationship between characteristics and security returns. Allowance for nonlinearity leads to increases in information ratios for factor portfolios neutralized with respect to nonlinear exposure to the other factors.