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Macroeconomic risk and asset pricing: estimating the apt with observable factors

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Abstract

This paper develops and applies a new maximum likelihood method for estimating the Arbitrage Pricing Theory (APT) model with observable risk factors. The approach involves simultaneous estimation of the factor loadings and risk premiums and can be applied to return panel with more securities than time series observations per security. Observable economic factors are found to account for 25 to 40 percent of the covariation in U.S. equity returns, and the APT pricing restrictions cannot be rejected for most sample periods. A significant \"firm size anomaly\" is measured, but it may be partly due to sample selection bias.

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  • John Ammer, 1993. "Macroeconomic risk and asset pricing: estimating the apt with observable factors," International Finance Discussion Papers 448, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:448
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    References listed on IDEAS

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    1. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-179, March.
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    3. Roll, Richard & Ross, Stephen A, 1980. "An Empirical Investigation of the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 35(5), pages 1073-1103, December.
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    5. Connor, Gregory & Korajczyk, Robert A., 1988. "Risk and return in an equilibrium APT : Application of a new test methodology," Journal of Financial Economics, Elsevier, vol. 21(2), pages 255-289, September.
    6. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    7. Campbell, John Y & Ammer, John, 1993. "What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," Journal of Finance, American Finance Association, vol. 48(1), pages 3-37, March.
    8. Burmeister, Edwin & McElroy, Marjorie B, 1988. " Joint Estimation of Factor Sensitivities and Risk Premia for the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 43(3), pages 721-733, July.
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    Cited by:

    1. John Ammer, 1996. "Macroeconomic state variables as determinants of asset price covariances," International Finance Discussion Papers 553, Board of Governors of the Federal Reserve System (U.S.).
    2. John Ammer, 1994. "Inflation, inflation risk, and stock returns," International Finance Discussion Papers 464, Board of Governors of the Federal Reserve System (U.S.).

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    Keywords

    Arbitrage; Macroeconomics;

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