A body-tail decomposition of the market portfolio shows the q5 factor model produces offsetting leg alphas unlike other models, despite good spanning performance.
Which Portfolios? The Construction Dependence of Factor Model Performance
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abstract
Factor-model performance depends not only on the model but also on how test assets are constructed. We form characteristic-unsorted random portfolios from a broad CRSP universe and vary stock selection, initial weighting, holding, and rebalancing. Rankings shift materially: buy-and-hold favors FF5 and FF6, whereas daily constant-weighting favors FF3, the most stable model across designs. Although q5 attains the highest maximum Sharpe ratio in factor-spanning tests, it leaves comparatively large and construction-sensitive pricing errors on random portfolios. These results reflect construction-specific weighting of each model's pricing-error vector. Test-asset construction, including dynamic weight management, is therefore a design choice in model evaluation.
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Anatomy of the Market: A Body-Tail Test of Factor Models
A body-tail decomposition of the market portfolio shows the q5 factor model produces offsetting leg alphas unlike other models, despite good spanning performance.