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Factor Representing Portfolios in Large Asset Markets

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  • Sentana, E.

Abstract

We study the properties of mimicking portfolios in an intertemporal APT model, in which the conditional mean and covariance matrix of returns vary in an interdependent manner. We use a signal extraction approach, and relate the efficiency of (possibly) dynamic basis portfolios to mean square error minimisation. We prove that many portfolios converge to the factors as the number of assets increases, but show that the conditional Kalman filter portfolios are the ones with both minimum tracking error variability, and maximum correlation with the common factors. We also show that our conclusions are unlikely to change when using parameter estimates.

Suggested Citation

  • Sentana, E., 2000. "Factor Representing Portfolios in Large Asset Markets," Papers 0001, Centro de Estudios Monetarios Y Financieros-.
  • Handle: RePEc:fth:cemfdt:0001
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    References listed on IDEAS

    as
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    6. Huberman, Gur & Kandel, Shmuel & Stambaugh, Robert F, 1987. "Mimicking Portfolios and Exact Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 42(1), pages 1-9, March.
    7. Stephen A. Ross, 2005. "Mutual Fund Separation in Financial Theory—The Separating Distributions," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 10, pages 309-356, World Scientific Publishing Co. Pte. Ltd..
    8. Grinblatt, Mark & Titman, Sheridan, 1987. "The Relation between Mean-Variance Efficiency and Arbitrage Pricing," The Journal of Business, University of Chicago Press, vol. 60(1), pages 97-112, January.
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    16. Sentana, Enrique & Fiorentini, Gabriele, 2001. "Identification, estimation and testing of conditionally heteroskedastic factor models," Journal of Econometrics, Elsevier, vol. 102(2), pages 143-164, June.
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    22. Connor, Gregory, 1984. "A unified beta pricing theory," Journal of Economic Theory, Elsevier, vol. 34(1), pages 13-31, October.
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    More about this item

    Keywords

    FINANCIAL MARKET ; ECONOMIC MODELS;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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