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Semiparametric Estimation of aCharacteristic-based Factor Model ofCommon Stock Returns

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Author Info
Gregory Connor
Oliver Linton

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Abstract

We introduce an alternative version of the Fama-French three-factor model of stockreturns together with a new estimation methodology. We assume that the factorbetas in the model are smooth nonlinear functions of observed securitycharacteristics. We develop an estimation procedure that combines nonparametrickernel methods for constructing mimicking portfolios with parametric nonlinearregression to estimate factor returns and factor betas simultaneously. Themethodology is applied to US common stocks and the empirical findings comparedto those of Fama and French.

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Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Econometrics Paper Series with number /2006/506.

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Date of creation: Sep 2006
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Handle: RePEc:cep:stiecm:/2006/506

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Related research
Keywords: characteristic-based factor model arbitrage pricing theory kernelestimation nonparametric estimation.

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Semiparametric and Nonparametric Methods

This paper has been announced in the following NEP Reports:

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  1. Daniel, Kent & Titman, Sheridan, 1997. " Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, vol. 52(1), pages 1-33, March. [Downloadable!] (restricted)
    Other versions:
  2. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June. [Downloadable!] (restricted)
  3. Connor, Gregory & Korajczyk, Robert A., 1988. "Risk and return in an equilibrium APT : Application of a new test methodology," Journal of Financial Economics, Elsevier, vol. 21(2), pages 255-289, September. [Downloadable!] (restricted)
  4. Robert J. Hodrick & David Tat-Chee Ng & Paul Sengmueller, 1999. "An International Dynamic Asset Pricing Model," NBER Working Papers 7157, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Davis, James L, 1994. " The Cross-Section of Realized Stock Returns: The Pre-COMPUSTAT Evidence," Journal of Finance, American Finance Association, vol. 49(5), pages 1579-93, December. [Downloadable!] (restricted)
  6. Daniel, Kent, et al, 1997. " Measuring Mutual Fund Performance with Characteristic-Based Benchmarks," Journal of Finance, American Finance Association, vol. 52(3), pages 1035-58, July. [Downloadable!] (restricted)
  7. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, vol. 9(1), pages 3-18, March. [Downloadable!] (restricted)
  8. Brown, Stephen J, 1989. " The Number of Factors in Security Returns," Journal of Finance, American Finance Association, vol. 44(5), pages 1247-62, December. [Downloadable!] (restricted)
  9. Fama, Eugene F & French, Kenneth R, 1995. " Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-55, March. [Downloadable!] (restricted)
  10. MacKinlay, A. Craig, 1995. "Multifactor models do not explain deviations from the CAPM," Journal of Financial Economics, Elsevier, vol. 38(1), pages 3-28, May. [Downloadable!] (restricted)
  11. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March. [Downloadable!] (restricted)
  12. W. H"Ardle & O. Linton, . "Nonparametric Regression," Sonderforschungsbereich 373 1995-29, Humboldt Universitaet Berlin.
  13. Connor, Gregory & Korajczyk, Robert A, 1993. " A Test for the Number of Factors in an Approximate Factor Model," Journal of Finance, American Finance Association, vol. 48(4), pages 1263-91, September. [Downloadable!] (restricted)
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