RCEA International Conference in Economics, Econometrics, and Finance - RCEA_ICEEF 2026, Madrid (Spain). 25-27 May 2026
Summary:
This methodological paper presents an alternative framework for studying the cross-section of returns through factor construction. We seek a factor definition that is mathematically consistent and establishes an assumptionfree architecture. The new framework is not only highly versatile and enables immediate economic analysis, but also overcomes well-known issues with discretionary choices reported in the literature. Graded factors, unlike their classical counterparts, offer intensity metrics and can be standardised for comparison across factors. Their additive nature enables factor decomposition and concurrent multi-factor analysis, unlocking opportunities for cross-sectional and time-series causal studies. We illustrate the properties of graded factors by applying the new framework to examine three classical problems in factor investing: the theoretical consistency of excess returns as recurring payoffs for risk, the interaction of size and value, and the effect of sector composition as an omitted variable. We also explore the interactions among the size, value, and greenness factors. Our work contributes to finance theory by offering a more objective, systematic approach to factor returns, with substantial implications for investment practices and firm valuation.
Spanish layman's summary:
Este artículo metodológico presenta un modelo alternativo de factores. Los factores graduados superan las limitaciones conocidas, ofrecen medidas de intensidad y posibilitan el análisis de efectos simultáneos y de los mecanismos causales.
English layman's summary:
This methodological paper presents an alternative framework for factor returns. Graded factors overcome reported limitations, offer intensity metrics and enable the analysis of joint effects and causal mechanisms. Our work contributes to theory by offering a systematic approach to factor returns.
Keywords: Asset Pricing, Factor Returns, Factor Investing, Cross-sectional Returns, Expected Returns, Corporate Social Responsibility, Environment
Publication date: 25-May-2026.
Citation:
J. Merladet, S. Lumbreras, A. Ramos, "Graded Factors: A New Approach to the Cross-section of Returns and Risk", presented at RCEA International Conference in Economics, Econometrics, and Finance - RCEA_ICEEF 2026, Madrid, Spain, 25-27 May 2026
IIT-26-155C
