Weak Signals, Small Bets: A Portfolio Perspective on Firm Characteristics

Abstract

We study how the choice between sparse variable selection and continuous shrinkage affects portfolio performance when many noisy stock characteristics compete for allocation. We find that transaction costs make this choice a first-order economic decision. Before costs, both approaches outperform passive benchmarks. After costs, sparse methods concentrate exposure in a few characteristics, generating turnover that leaves the investor worse off than the benchmarks. Shrinkage distributes exposure across many characteristics, preserving net-of-cost gains. This gap widens during financial stress, when trading frictions are highest, and is robust across investment universes, leverage constraints, alternative shrinkage priors, and multiple transaction cost calibrations.

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Awards

REAG Investimentos Best Articles Award, XXV Brazilian Finance Meeting at INSPER.

Presentations

Alpine Finance Summit (scheduled), Barcelona Workshop in Financial Econometrics, 11th Italian Congress of Econometrics and Empirical Economics, XXV Brazilian Finance Meeting at INSPER.

Citation

Bianchi, Daniele, and Pedro H. M. Venturi. Weak Signals, Small Bets: A Portfolio Perspective on Firm Characteristics. Working paper.

@article{bianchi2024weak,
  title={Weak Signals, Small Bets: A Portfolio Perspective on Firm Characteristics},
  author={Bianchi, Daniele and Venturi, Pedro},
  journal={Small Bets: A Portfolio Perspective on Firm Characteristics (July 27, 2024)},
  year={2024}
}