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Testing Linear Factor Pricing Models With Large Cross Sections: A Distribution-Free Approach

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  • Sermin Gungor
  • Richard Luger

Abstract

In this article, we develop a finite-sample distribution-free procedure to test the beta-pricing representation of linear factor pricing models. In sharp contrast to extant finite-sample tests, our framework allows for unknown forms of nonnormalities, heteroscedasticity, and time-varying covariances. The power of the proposed test procedure increases as the time series lengthens and/or the cross section becomes larger. So the criticism sometimes heard that nonparametric tests lack power does not apply here, since the number of test assets is chosen by the user. This also stands in contrast to the usual tests that lose power or may not even be computable if the number of test assets is too large. Supplementary materials for this article are available online.

Suggested Citation

  • Sermin Gungor & Richard Luger, 2013. "Testing Linear Factor Pricing Models With Large Cross Sections: A Distribution-Free Approach," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 31(1), pages 66-77, January.
    • Handle: RePEc:taf:jnlbes:v:31:y:2013:i:1:p:66-77
    DOI: 10.1080/07350015.2012.740435
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    Cited by:

    1. Pesaran, M. Hashem & Yamagata, Takashi, 2012. "Testing CAPM with a Large Number of Assets," IZA Discussion Papers 6469, Institute of Labor Economics (IZA).
    2. Gungor, Sermin & Luger, Richard, 2015. "Bootstrap Tests Of Mean-Variance Efficiency With Multiple Portfolio Groupings," L'Actualité Economique, Société Canadienne de Science Economique, vol. 91(1-2), pages 35-65, Mars-Juin.
    3. Daniele Bianchi & Massimo Guidolin & Francesco Ravazzolo, 2017. "Macroeconomic Factors Strike Back: A Bayesian Change-Point Model of Time-Varying Risk Exposures and Premia in the U.S. Cross-Section," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 35(1), pages 110-129, January.
    4. Sermin Gungor & Richard Luger, 2016. "Multivariate Tests of Mean-Variance Efficiency and Spanning With a Large Number of Assets and Time-Varying Covariances," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 34(2), pages 161-175, April.
    5. Fan, Jianqing & Ke, Yuan & Liao, Yuan, 2021. "Augmented factor models with applications to validating market risk factors and forecasting bond risk premia," Journal of Econometrics, Elsevier, vol. 222(1), pages 269-294.
    6. Pesaran, M. H. & Yamagata, T., 2012. "Testing CAPM with a Large Number of Assets (Updated 28th March 2012)," Cambridge Working Papers in Economics 1210, Faculty of Economics, University of Cambridge.
    7. Mardy Chiah & Daniel Chai & Angel Zhong & Song Li, 2016. "A Better Model? An Empirical Investigation of the Fama–French Five-factor Model in Australia," International Review of Finance, International Review of Finance Ltd., vol. 16(4), pages 595-638, December.
    8. Auld, T., 2022. "Political markets as equity price factors," Cambridge Working Papers in Economics 2264, Faculty of Economics, University of Cambridge.

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