We investigate how transaction costs change the number of characteristics that are jointly significant for an investor’s optimal portfolio, and hence, how they change the dimension of the cross section of stock returns. We find that transaction costs increase the number of significant characteristics from six to 15. The explanation is that, as we show theoretically and empirically, combining characteristics reduces transaction costs because the trades in the underlying stocks required to rebalance different characteristics often cancel out. Thus, transaction costs provide an economic rationale for considering a larger number of characteristics than that in prominent asset-pricing models.
This is a pre-copy-editing, author-produced PDF of an article accepted for publication in The Review of Financial Studies following peer review. The definitive publisher-authenticated version Victor DeMiguel, Alberto Martín-Utrera, Francisco J Nogales, Raman Uppal, A Transaction-Cost Perspective on the Multitude of Firm Characteristics, The Review of Financial Studies, Volume 33, Issue 5, May 2020, Pages 2180–2222 is available online at: https://academic.oup.com/rfs/article-abstract/33/5/2180/5821387
