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Multifactor Models and Their Consistency with the APT
[Eigenvalue ratio test for the number of factors]

Author

Listed:
  • Ilan Cooper
  • Liang Ma
  • Paulo Maio
  • Dennis Philip

Abstract

We examine the consistency of several prominent multifactor models from the empirical asset pricing literature with the arbitrage pricing theory (APT) framework. We follow the APT-related literature and estimate the common factor structure from a rich cross-section (associated with 42 major CAPM anomalies) by employing the asymptotic principal components method. Our benchmark model contains six statistical factors and clearly dominates, in both economic and statistical terms, most of the empirical multifactor models proposed in the literature by a good margin. These results represent a critical challenge to the current workhorse models in terms of explaining large-scale equity risk premiums. (JEL G10, G12) Received December 27, 2019; editorial decision October 20, 2020 by Editor Thierry Foucault. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • Ilan Cooper & Liang Ma & Paulo Maio & Dennis Philip, 2021. "Multifactor Models and Their Consistency with the APT [Eigenvalue ratio test for the number of factors]," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 11(2), pages 402-444.
    • Handle: RePEc:oup:rasset:v:11:y:2021:i:2:p:402-444.
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    File URL: http://hdl.handle.net/10.1093/rapstu/raaa024
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    Citations

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    Cited by:

    1. Pätäri, Eero & Ahmed, Sheraz & Luukka, Pasi & Yeomans, Julian Scott, 2023. "Can monthly-return rank order reveal a hidden dimension of momentum? The post-cost evidence from the U.S. stock markets," The North American Journal of Economics and Finance, Elsevier, vol. 65(C).
    2. Cong, Lin William & George, Nathan Darden & Wang, Guojun, 2023. "RIM-based value premium and factor pricing using value-price divergence," Journal of Banking & Finance, Elsevier, vol. 149(C).
    3. Angelidis, Timotheos & Tessaromatis, Nikolaos, 2023. "The disappearing profitability of volatility-managed equity factors," Journal of Financial Markets, Elsevier, vol. 65(C).

    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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