Kelly, BryanMalamud, SemyonPedersen, Lasse Heje2023-01-302023-01-302023-01-302022-12-2710.1111/jofi.13199https://infoscience.epfl.ch/handle/20.500.14299/194464WOS:000904753000001We propose a new asset pricing framework in which all securities' signals predict each individual return. While the literature focuses on securities' own-signal predictability, assuming equal strength across securities, our framework includes cross-predictability-leading to three main results. First, we derive the optimal strategy in closed form. It consists of eigenvectors of a "prediction matrix," which we call "principal portfolios." Second, we decompose the problem into alpha and beta, yielding optimal strategies with, respectively, zero and positive factor exposure. Third, we provide a new test of asset pricing models. Empirically, principal portfolios deliver significant out-of-sample alphas to standard factors in several data sets.Business, FinanceEconomicsBusiness & Economicstext::journal::journal article::research article