# Efficient sorting: a more powerful test for cross-sectional anomalies

Ledoit, Olivier; Wolf, Michael; Zhao, Zhao (2018). Efficient sorting: a more powerful test for cross-sectional anomalies. Working paper series / Department of Economics 238, University of Zurich.

## Abstract

Many researchers seek factors that predict the cross-section of stock returns. The standard methodology sorts stocks according to their factor scores into quantiles and forms a corresponding long-short portfolio. Such a course of action ignores any information on the covariance matrix of stock returns. Historically, it has been difficult to estimate the covariance matrix for a large universe of stocks. We demonstrate that using the recent DCC-NL estimator of Engle et al. (2017) substantially enhances the power of tests for cross-sectional anomalies: On average, Student' t-statistics more than double.

## Abstract

Many researchers seek factors that predict the cross-section of stock returns. The standard methodology sorts stocks according to their factor scores into quantiles and forms a corresponding long-short portfolio. Such a course of action ignores any information on the covariance matrix of stock returns. Historically, it has been difficult to estimate the covariance matrix for a large universe of stocks. We demonstrate that using the recent DCC-NL estimator of Engle et al. (2017) substantially enhances the power of tests for cross-sectional anomalies: On average, Student' t-statistics more than double.

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Item Type: Working Paper 03 Faculty of Economics > Department of Economics Working Paper Series > Department of Economics 330 Economics C13, C58, G11 Cross-section of returns, dynamic conditional correlations, GARCH, Markowitz portfolio selection, nonlinear shrinkage English May 2018 06 Dec 2016 15:20 26 Jul 2018 06:10 Working paper series / Department of Economics 51 1664-7041 Revised version ; Former titles: Beyond sorting: a more powerful test for cross-sectional anomalies ; Efficient weighting: a more powerful test for cross-sectional anomalies Green http://www.econ.uzh.ch/static/wp/econwp238.pdf http://www.econ.uzh.ch/static/workingpapers.php

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