Evaluating the Importance of Missing Risk Factors Using the Optimal Orthogonal Portfolio Approach
We apply the orthogonal portfolio approach to analyse the importance of risk factors potentially missing from the CAPM. We generalize the approach proposed by MacKinlay and Pastor (2000) [MacKinlay, A.C., Pastor, L., 2000. Asset pricing models: implications for expected returns and portfolio selection. Review of Financial Studies 13, 883–916] by estimating the Sharpe ratio of the optimal orthogona