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Explaining the single factor bias of arbitrage pricing models in finite samples

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  • Harding, Matthew C.

Abstract

This paper shows that in finite samples it is not possible to distinguish all the latent factors from the idiosyncratic noise and that this leads to a bias towards the identification of a single factor. It provides an approximation to this bias and the corresponding sampling distribution.

Suggested Citation

  • Harding, Matthew C., 2008. "Explaining the single factor bias of arbitrage pricing models in finite samples," Economics Letters, Elsevier, vol. 99(1), pages 85-88, April.
    • Handle: RePEc:eee:ecolet:v:99:y:2008:i:1:p:85-88
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    References listed on IDEAS

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    1. Trzcinka, Charles A, 1986. "On the Number of Factors in the Arbitrage Pricing Model," Journal of Finance, American Finance Association, vol. 41(2), pages 347-368, June.
    2. Stephen A. Ross, 2013. "The Arbitrage Theory of Capital Asset Pricing," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 1, pages 11-30, World Scientific Publishing Co. Pte. Ltd..
    3. 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 1263-1291, September.
    4. Geweke, John & Zhou, Guofu, 1996. "Measuring the Pricing Error of the Arbitrage Pricing Theory," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 557-587.
    5. Jinyong Hahn & Guido Kuersteiner, 2002. "Asymptotically Unbiased Inference for a Dynamic Panel Model with Fixed Effects when Both "n" and "T" Are Large," Econometrica, Econometric Society, vol. 70(4), pages 1639-1657, July.
    6. Brown, Stephen J, 1989. " The Number of Factors in Security Returns," Journal of Finance, American Finance Association, vol. 44(5), pages 1247-1262, December.
    7. Chamberlain, Gary & Rothschild, Michael, 1983. "Arbitrage, Factor Structure, and Mean-Variance Analysis on Large Asset Markets," Econometrica, Econometric Society, vol. 51(5), pages 1281-1304, September.
    8. Jones, Christopher S., 2001. "Extracting factors from heteroskedastic asset returns," Journal of Financial Economics, Elsevier, vol. 62(2), pages 293-325, November.
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    Cited by:

    1. Marie-Hélène Broihanne & Maxime Merli & Patrick Roger, 2016. "Diversification, gambling and market forces," Review of Quantitative Finance and Accounting, Springer, vol. 47(1), pages 129-157, July.
    2. Chadwick, Meltem, 2010. "Performance of Bayesian Latent Factor Models in Measuring Pricing Errors," MPRA Paper 79060, University Library of Munich, Germany.
    3. Patrick Roger & Marie-Hélène Broihanne & Maxime Merli, 2012. "In search of positive skewness: the case of individual investors," Working Papers of LaRGE Research Center 2012-04, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg.
    4. Jaskowski, Marcin & McAleer, Michael, 2021. "Spurious cross-sectional dependence in credit spread changes," Econometrics and Statistics, Elsevier, vol. 18(C), pages 12-27.
    5. Edoardo Saccenti & Marieke E. Timmerman, 2017. "Considering Horn’s Parallel Analysis from a Random Matrix Theory Point of View," Psychometrika, Springer;The Psychometric Society, vol. 82(1), pages 186-209, March.

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