Marcos M. Causal Factor Investing 2023

Textbook in PDF format

Virtually all journal articles in the factor investing literature make associational claims, in denial of the causal content of factor models. Authors do not identify the causal graph consistent with the observed phenomenon, they justify their chosen model specification in terms of correlations, and they do not propose experiments for falsifying causal mechanisms. Absent a causal theory, their findings are likely false, due to rampant backtest overfitting and incorrect specification choices. This Element differentiates between type-A and type-B spurious claims, and explains how both types prevent factor investing from advancing beyond its current phenomenological stage. It analyzes the current state of causal confusion in the factor investing literature, and proposes solutions with the potential to transform factor investing into a truly scientific discipline.
1 Introduction
2 Association vs Causation
3 The Three Steps of Scientific Discovery
4 Causal Inference
5 Causality in Econometrics
6 Causality in Factor Investing
7 Monte Carlo Experiments
8 Conclusions
Appendix
References