Time-Series Efficient Factors

Abstract

Factors in prominent asset pricing models are positively autocorrelated. We derive a transformation that turns an autocorrelated factor to a ``time-series efficient'' factor. Time-series efficient factors earn significantly higher Sharpe ratios than the original factors and contain all the information found in the original factors. Momentum strategies profit from the same predictable variation in factor premiums as time-series efficient factors. An asset pricing model with time-series efficient factors, such as an efficient Fama-French five-factor model, therefore prices momentum.