Portfolio optimization under asset pricing anomalies

Pin Huang Chou, Wen Shen Li, Guofu Zhou

Research output: Contribution to journalArticlepeer-review

7 Scopus citations


Fama and French (1993) find that the SMB and the HML factors explain much of the cross-section stock returns that are unexplained by the CAPM, whereas Daniel and Titman (1997) show that it is the characteristics of the stocks that are responsible rather than the factors. But both arguments are largely based only on expected return comparisons, and little is known about how important each of the two explanations matters to an investor's investment decisions in general and portfolio optimization in particular. In this paper, we show that a mean-variance maximizing investor who exploits the asset pricing anomaly of the CAPM can achieve substantial economic gain than simply holding the market index. Indeed, using monthly Japanese data on the first 50 largest stocks over the period 1980-1997, we find the optimized portfolio constructed from characteristics-based model is the best performing one and has monthly returns more than 0.81 percent (10.16 percent annualized) over the Nikkei 225 index with no greater risk.

Original languageEnglish
Pages (from-to)121-142
Number of pages22
JournalJapan and the World Economy
Issue number2
StatePublished - Mar 2006


  • Characteristics
  • Factors
  • Momentum
  • Portfolio selection


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