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Testing conditional factor models: A nonparametric approach

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  • Li, Yan
  • Yang, Liyan
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    Abstract

    Some recent studies of conditional factor models do not specify conditioning information but use data from small windows to estimate the time series of conditional alphas and betas. In this paper, we propose a nonparametric method using an optimal window to estimate time-varying coefficients. In addition, we offer two empirical tests of a conditional factor model. Using our new method, we examine the performance of the conditional CAPM and the conditional Fama–French three-factor model in explaining the return variations of portfolios sorted by size, book-to-market ratios, and past returns, for which recent literature has generated controversial results. We find that, although in general the conditional FF model outperforms the conditional CAPM, both models fail to explain well-known asset-pricing anomalies. Moreover, for both models, the failure is more pronounced for the equally-weighted portfolios than for the value-weighted ones.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 18 (2011)
    Issue (Month): 5 ()
    Pages: 972-992

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    Handle: RePEc:eee:empfin:v:18:y:2011:i:5:p:972-992

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    Web page: http://www.elsevier.com/locate/jempfin

    Related research

    Keywords: Conditional CAPM; Conditional Fama–French three-factor model; Momentum; Nonparametric method; Size; Value;

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    Cited by:
    1. Kinnunen, Jyri, 2013. "Dynamic return predictability in the Russian stock market," Emerging Markets Review, Elsevier, vol. 15(C), pages 107-121.
    2. Zárraga Alonso, Ainhoa & Nieto Domenech, Belén & Orbe Mandaluniz, Susan, 2011. "Time-Varying Beta Estimators in the Mexican Emerging Market," BILTOKI 2011-06, Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística).
    3. Ang, Andrew & Kristensen, Dennis, 2012. "Testing conditional factor models," Journal of Financial Economics, Elsevier, vol. 106(1), pages 132-156.
    4. Corradi, Valentina & Distaso, Walter & Fernandes, Marcelo, 2013. "Conditional alphas and realized betas," Textos para discussão 341, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).

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