Bank Testing Linear Factor Pricing Models with Large Cross-Sections: A Distribution-Free Approach
AbstractWe develop a finite-sample procedure to test the beta-pricing representation of linear factor pricing models that is applicable even if the number of test assets is greater than the length of the time series. Our distribution-free framework leaves open the possibility of unknown forms of non-normalities, heteroskedasticity, time-varying correlations, and even outliers in the asset returns. The power of the proposed test procedure increases as the time-series lengthens and/or the cross-section becomes larger. This stands in sharp contrast to the usual tests that lose power or may not even be computable if the cross-section is too large. Finally, we revisit the CAPM and the Fama-French three factor model. Our results strongly support the mean-variance efficiency of the market portfolio.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 10-36.
Length: 59 pages
Date of creation: 2010
Date of revision:
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Econometric and statistical methods; Financial markets;
Find related papers by JEL classification:
- C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Longitudinal Data; Spatial Time Series
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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