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Causal Factor Analysis is a Necessary Condition for Investment Efficiency.

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Název: Causal Factor Analysis is a Necessary Condition for Investment Efficiency.
Autoři: López de Prado, Marcos1 (AUTHOR) marcos.lopezdeprado@adia.ae, Lipton, Alexander2 (AUTHOR) alexander.lipton@adia.ae, Zoonekynd, Vincent3 (AUTHOR) vincent.zoonekynd@adia.ae
Zdroj: Journal of Portfolio Management. Nov2025, Vol. 52 Issue 1, p7-19. 13p.
Témata: *PORTFOLIO management (Investments), *RISK-return relationships, *ASSET management, *CAPITAL allocation, CAUSAL models, CAUSATION (Philosophy)
Abstrakt: This article reveals the dire consequences of factor model misspecification in the context of portfolio optimization. The authors show that it is impossible to estimate the efficient frontier without a causal factor model, and that the prevailing (associational) factor-modeling paradigm leads to investment inefficiency. Furthermore, they show that the biases introduced by factor model misspecification can be so large as to produce portfolios in which investors buy what they should sell, and vice versa, even if investors have perfect knowledge of the mean and covariances. Their findings challenge the scientific soundness of the portfolio construction paradigms currently used by the asset management industry. To overcome these pitfalls, academics and practitioners should rebuild the financial economics literature on the more scientifically rigorous grounds of causal factor investing. [ABSTRACT FROM AUTHOR]
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Abstrakt:This article reveals the dire consequences of factor model misspecification in the context of portfolio optimization. The authors show that it is impossible to estimate the efficient frontier without a causal factor model, and that the prevailing (associational) factor-modeling paradigm leads to investment inefficiency. Furthermore, they show that the biases introduced by factor model misspecification can be so large as to produce portfolios in which investors buy what they should sell, and vice versa, even if investors have perfect knowledge of the mean and covariances. Their findings challenge the scientific soundness of the portfolio construction paradigms currently used by the asset management industry. To overcome these pitfalls, academics and practitioners should rebuild the financial economics literature on the more scientifically rigorous grounds of causal factor investing. [ABSTRACT FROM AUTHOR]
ISSN:00954918
DOI:10.3905/jpm.2025.1.760