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Bayesian variable selection and model averaging in the arbitrage pricing theory model

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  • Ouysse, Rachida
  • Kohn, Robert

Abstract

Empirical tests of the arbitrage pricing theory using measured variables rely on the accuracy of standard inferential theory in approximating the distribution of the estimated risk premiums and factor betas. The techniques employed thus far perform factor selection and model inference sequentially. Recent advances in Bayesian variable selection are adapted to an approximate factor model to investigate the role of measured economic variables in the pricing of securities. In finite samples, exact statistical inference is carried out using posterior distributions of functions of risk premiums and factor betas. The role of the panel dimensions in posterior inference is investigated. New empirical evidence is found of time-varying risk premiums with higher and more volatile expected compensation for bearing systematic risk during contraction phases. In addition, investors are rewarded for exposure to "Economic" risk.

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  • Ouysse, Rachida & Kohn, Robert, 2010. "Bayesian variable selection and model averaging in the arbitrage pricing theory model," Computational Statistics & Data Analysis, Elsevier, vol. 54(12), pages 3249-3268, December.
  • Handle: RePEc:eee:csdana:v:54:y:2010:i:12:p:3249-3268
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    Cited by:

    1. Rachida Ouysse, 2011. "Comparison of Bayesian moving Average and Principal Component Forecast for Large Dimensional Factor Models," Discussion Papers 2012-03, School of Economics, The University of New South Wales.
    2. Massimo Guidolin & Francesco Ravazzolo & Andrea Tortora, 2014. "Myths and Facts about the Alleged Over-Pricing of U.S. Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 49(4), pages 477-523, November.
    3. Massimo Guidolin & Francesco Ravazzolo & Andrea Donato Tortora, 2011. "Myths and Facts about the Alleged Over-Pricing of U.S. Real Estate. Evidence from Multi-Factor Asset Pricing Models of REIT Returns," Working Papers 416, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    4. Ouysse, Rachida, 2016. "Bayesian model averaging and principal component regression forecasts in a data rich environment," International Journal of Forecasting, Elsevier, vol. 32(3), pages 763-787.
    5. Guidolin, Massimo & Ravazzolo, Francesco & Tortora, Andrea Donato, 2013. "Alternative econometric implementations of multi-factor models of the U.S. financial markets," The Quarterly Review of Economics and Finance, Elsevier, vol. 53(2), pages 87-111.
    6. Salotti, Simone & Trecroci, Carmine, 2014. "Multifactor risk loadings and abnormal returns under uncertainty and learning," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(3), pages 393-404.
    7. Magnus, Jan R. & Wan, Alan T.K. & Zhang, Xinyu, 2011. "Weighted average least squares estimation with nonspherical disturbances and an application to the Hong Kong housing market," Computational Statistics & Data Analysis, Elsevier, vol. 55(3), pages 1331-1341, March.
    8. Faruque, Muhammad U, 2011. "An empirical investigation of the arbitrage pricing theory in a frontier stock market: evidence from Bangladesh," MPRA Paper 38675, University Library of Munich, Germany.

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