We propose a new approach for estimating expected returns on individual stocks from a large number of firm characteristics. We treat expected returns as latent variables and apply the partial least squares (PLS) estimator that filters them out from the characteristics under an assumption that...

This paper studies how acquisition of non-fundamental information (learning about noise) affects financial markets. We develop a rational expectations model with investors who are endowed with fundamental and non-fundamental information of heterogeneous quality and who optimally allocate...

We theoretically analyze how index investing affects financial markets using a dynamic exchange economy with heterogeneous investors and two Lucas trees. We identify two effects of indexing: lockstep trading of stocks increases market volatility and stock return correlations but reduction in...