Asset Pricing Tests Using Random Portfolios

Results from two-stage asset pricing tests vary with the type and number of test assets. First, implied factor premia from systematic portfolios as test assets depend on the level of aggregation. Randomly generated portfolios yield results that are consistent with a reduction in measurement error and robust to the arbitrary level of aggregation. Qualitative results generally converge when more assets are used, i.e., when aggregation decreases. Second, the market and HML factor premia are strongly dependent on the distinction between explaining and predicting returns