Alejandro Lopez-Lira, Finance, The Wharton School
Abstract: What are the fundamental risks in the economy? Which risks are systematic? Which risks are priced? Are the risks summarized well by existing models? I use machine learning to identify the risks that firms face based on their annual reports. The risks are described in plain words, and the most discussed risks are Innovation Risk, Demand Risk, Production Risk, International Risk, and Property Risk. I quantify how much each firm is exposed to each risk, design a test to classify them into systematic and idiosyncratic, and construct portfolios proxying for each risk. The portfolios are not spanned by the traditional factors. A factor model formed with the most discussed risks performs at least as good as the traditional ones, while not using any information from past returns.