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Characteristic-Sorted Portfolios: Estimation and Inference
Portfolio sorting is ubiquitous in the empirical finance literature, where it has been widely used to identify pricing anomalies. Despite its popularity, little attention has been paid to the statistical properties of the procedure. We develop a general framework for portfolio sorting by casting it as a nonparametric estimator. We present valid asymptotic inference methods, and a valid mean square error expansion of the estimator leading to an optimal choice for the number of portfolios. In practical settings, the optimal choice may be much larger than standard choices of five or ten. To ...
Report
On binscatter
Binscatter is a popular method for visualizing bivariate relationships and conducting informal specification testing. We study the properties of this method formally and develop enhanced visualization and econometric binscatter tools. These include estimating conditional means with optimal binning and quantifying uncertainty. We also highlight a methodological problem related to covariate adjustment that can yield incorrect conclusions. We revisit two applications using our methodology and find substantially different results relative to those obtained using prior informal binscatter methods. ...