In the finance literature, a common practice is to create factor-portfolios by sorting on characteristics (such as book-to-market, profitability or investment) associated with average returns. The goal of this exercise is to create a parsimonious set of factor-portfolios that explain the...

Recent theories suggest that both risk and mispricing are associated with commonality in security returns, and that the loadings on characteristic-based factors can be used to predict future returns. We supplement the market factor with two mispricing factors which capture long- and...