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

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  • Sermin Gungor
  • Richard Luger

Abstract

We 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 Info

Paper provided by Bank of Canada in its series Working Papers with number 10-36.

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Length: 59 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bca:bocawp:10-36

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Keywords: Econometric and statistical methods; Financial markets;

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