Where Are the Factors in Factor Investing?

Abstract

In this article, the author advocates for the use of causal graphs to modernize the field of factor investing and set it on a logically coherent foundation. To do this, first he introduces the concepts of association and causation. Second, he explains the use of causal graphs and the real (causal) meaning of the ceteris paribus assumption that is so popular among economists. Third, he explains how causal graphs help us estimate causal effects in observational (nonexperimental) studies. Fourth, he illustrates all of the earlier concepts with Monte Carlo experiments. He concludes that the field of factor investing must embrace causal graphs in order to wake up from its associational slumber.