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Specification Lasso and an Application in Financial Markets

Author

Listed:
  • Dong, C.
  • Li, S.

Abstract

This paper proposes the method of Specification-LASSO in a flexible semi-parametric regression model that allows for the interactive effects between different covariates. Specification-LASSO extends LASSO and Adaptive Group LASSO to achieve both relevant variable selection and model specification. Specification-LASSO also gives preliminary estimates that facilitate the estimation of the regression model. Monte Carlo simulations show that the Specification-LASSO can accurately specify partially linear additive models with interactive regressors. Finally, the proposed methods are applied in an empirical study, which examines the topic proposed by Freyberger et al. (2020), which argues that firms' sizes may have interactive effects with other security-specific characteristics, which can explain the stocks excess returns together.

Suggested Citation

  • Dong, C. & Li, S., 2021. "Specification Lasso and an Application in Financial Markets," Cambridge Working Papers in Economics 2139, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:2139
    Note: sl736
    as

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    References listed on IDEAS

    as
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    5. Hua Liang & Sally W. Thurston & David Ruppert & Tatiyana Apanasovich & Russ Hauser, 2008. "Additive partial linear models with measurement errors," Biometrika, Biometrika Trust, vol. 95(3), pages 667-678.
    6. Joachim Freyberger & Andreas Neuhierl & Michael Weber & Andrew KarolyiEditor, 2020. "Dissecting Characteristics Nonparametrically," Review of Financial Studies, Society for Financial Studies, vol. 33(5), pages 2326-2377.
    7. Wang, Hansheng & Leng, Chenlei, 2008. "A note on adaptive group lasso," Computational Statistics & Data Analysis, Elsevier, vol. 52(12), pages 5277-5286, August.
    8. Li, Qi, 2000. "Efficient Estimation of Additive Partially Linear Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(4), pages 1073-1092, November.
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    Keywords

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    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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