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A Pricing Operator‐Based Testing Foundation For A Class Of Factor Pricing Models

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  • Zhiwu Chen
  • Peter J. Knez

Abstract

This paper develops a cross‐market version of factor pricing models. It is shown that exact factor pricing holds across two submarkets with respect to their common factors if and only if the unique pricing operator for the first submarket is equal to that for the other submarket with probability 1. We define an APT measure as the squared distance between the two pricing operators. Then, testing whether this measure is zero is equivalent to testing exact factor pricing across the two submarkets. Since the estimation of this measure does not require parameterizing and extracting the underlying factors, one can test factor pricing models without knowing any factors. In addition, we present a randomization procedure so that one can use it to conduct a more comprehensive investigation on the empirical robustness of factor pricing models.

Suggested Citation

  • Zhiwu Chen & Peter J. Knez, 1994. "A Pricing Operator‐Based Testing Foundation For A Class Of Factor Pricing Models," Mathematical Finance, Wiley Blackwell, vol. 4(2), pages 121-141, April.
    • Handle: RePEc:bla:mathfi:v:4:y:1994:i:2:p:121-141
    DOI: 10.1111/j.1467-9965.1994.tb00053.x
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