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When A Factor Is Measured with Error: The Role of Conditional Heteroskedasticity in Identifying and Estimating Linear Factor Models

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  • Prono, Todd
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    Abstract

    A new method is proposed for estimating linear triangular models, where identification results from the structural errors following a bivariate and diagonal GARCH(1,1) process. The associated estimator is a GMM estimator shown to have the usual √T-asymptotics. A Monte Carlo study of the estimator is provided as is an empirical application of estimating market betas from the CAPM. These market beta estimates are found to be statistically distinct from their OLS counterparts and to display expanded cross-sectional variation, the latter feature offering promise for their ability to provide improved pricing of cross-sectional expected returns.

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    File URL: http://mpra.ub.uni-muenchen.de/33593/
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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 33593.

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    Date of creation: 19 Sep 2011
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    Handle: RePEc:pra:mprapa:33593

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    Keywords: Measurement error; triangular models; factor models; heteroskedasticity; identification; many moments; GMM;

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    3. J. Ginger Meng & Gang Hu & Jushan Bai, 2011. "Olive: A Simple Method For Estimating Betas When Factors Are Measured With Error," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 34(1), pages 27-60, 03.
    4. Gabriele Fiorentini & Enrique Sentana Iváñez, 1997. "Identification, estimation and testing of conditionally heteroskedastic factor models," Working Papers. Serie AD 1997-22, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
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    7. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
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    16. Whitney K. Newey & Frank Windmeijer, 2009. "Generalized Method of Moments With Many Weak Moment Conditions," Econometrica, Econometric Society, vol. 77(3), pages 687-719, 05.
    17. Lewellen, Jonathan & Nagel, Stefan, 2003. "The Conditional CAPM Does Not Explain Asset-pricing Anomalies," Working papers 4427-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    18. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
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    21. Hansen, Lars Peter & Heaton, John & Yaron, Amir, 1996. "Finite-Sample Properties of Some Alternative GMM Estimators," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(3), pages 262-80, July.
    22. Carrasco, Marine & Chen, Xiaohong, 2002. "Mixing And Moment Properties Of Various Garch And Stochastic Volatility Models," Econometric Theory, Cambridge University Press, vol. 18(01), pages 17-39, February.
    23. Todd, Prono, 2009. "GARCH-Based Identification and Estimation of Triangular Systems," MPRA Paper 20032, University Library of Munich, Germany.
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