Integrating Factor Models


This paper proposes a comprehensive framework to address uncertainty about the correct factor model. Asset pricing inferences draw on a composite model that integrates over candidate models using posterior probabilities as weights. Evidence shows that (i) considerable time-varying mispricing exists, (ii) unconditional models record near-zero probabilities, and (iii) the post-earnings announcement drift, quality-minus-junk, and intermediary capital factors are incremental to the market. From an investment perspective, an optimizing agent who accounts for model uncertainty perceives equities considerably riskier relative to sample estimates, and the integrated model delivers stable performance even during market downturns.