In addition to a priced, dominant market factor (DMF), the value-weighted market stock return contains an “idiosyncratic financial factor” (IFF) related to overweighting of large-cap stocks. The IFF carries no risk premium, is unrelated to macroeconomic factors and returns in other markets, and significantly impacts systematic risk estimates. Size factors separate exposures to the DMF from the IFF. Consistent with a model with nontraded assets, using the DMF as an alternative market factor resolves the size anomaly and obviates the need for size factors in multifactor models. Finally, the DMF features a stronger intertemporal risk-return tradeoff.
