In the finance literature, a common practice is to create characteristic portfolios by sorting on characteristics associated with average returns. We show that the resulting portfolios are likely to capture not only the priced risk associated with the characteristic, but also unpriced risk. We...

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...