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Semiparametric Conditional Factor Models: Estimation and Inference

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  • Qihui Chen
  • Nikolai Roussanov
  • Xiaoliang Wang

Abstract

This paper introduces a simple and tractable sieve estimation of semiparametric conditional factor models with latent factors. We establish large-N-asymptotic properties of the estimators without requiring large T. We also develop a simple bootstrap procedure for conducting inference about the conditional pricing errors as well as the shapes of the factor loading functions. These results enable us to estimate conditional factor structure of a large set of individual assets by utilizing arbitrary nonlinear functions of a number of characteristics without the need to pre-specify the factors, while allowing us to disentangle the characteristics' role in capturing factor betas from alphas (i.e., undiversifiable risk from mispricing). We apply these methods to the cross-section of individual U.S. stock returns and find strong evidence of large nonzero pricing errors that combine to produce arbitrage portfolios with Sharpe ratios above 3. We also document a significant decline in apparent mispricing over time.

Suggested Citation

  • Qihui Chen & Nikolai Roussanov & Xiaoliang Wang, 2023. "Semiparametric Conditional Factor Models: Estimation and Inference," NBER Working Papers 31817, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:31817
    Note: AP CF IFM IO LS
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    References listed on IDEAS

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    1. Jushan Bai & Serena Ng, 2002. "Determining the Number of Factors in Approximate Factor Models," Econometrica, Econometric Society, vol. 70(1), pages 191-221, January.
    2. Seung C. Ahn & Alex R. Horenstein, 2013. "Eigenvalue Ratio Test for the Number of Factors," Econometrica, Econometric Society, vol. 81(3), pages 1203-1227, May.
    3. Qihui Chen & Zheng Fang, 2018. "Improved Inference on the Rank of a Matrix," Papers 1812.02337, arXiv.org, revised Mar 2019.
    4. Luyang Chen & Markus Pelger & Jason Zhu, 2019. "Deep Learning in Asset Pricing," Papers 1904.00745, arXiv.org, revised Aug 2021.
    5. Belloni, Alexandre & Chernozhukov, Victor & Chetverikov, Denis & Kato, Kengo, 2015. "Some new asymptotic theory for least squares series: Pointwise and uniform results," Journal of Econometrics, Elsevier, vol. 186(2), pages 345-366.
    6. 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.
    7. Chen, Xiaohong, 2007. "Large Sample Sieve Estimation of Semi-Nonparametric Models," Handbook of Econometrics, in: J.J. Heckman & E.E. Leamer (ed.), Handbook of Econometrics, edition 1, volume 6, chapter 76, Elsevier.
    8. John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, vol. 66(4), pages 1047-1108, August.
    9. Jushan Bai, 2003. "Inferential Theory for Factor Models of Large Dimensions," Econometrica, Econometric Society, vol. 71(1), pages 135-171, January.
    10. Qihui Chen & Zheng Fang, 2019. "Improved inference on the rank of a matrix," Quantitative Economics, Econometric Society, vol. 10(4), pages 1787-1824, November.
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    Cited by:

    1. Alain-Philippe Fortin & Patrick Gagliardini & O. Scaillet, 2022. "Eigenvalue tests for the number of latent factors in short panels," Swiss Finance Institute Research Paper Series 22-81, Swiss Finance Institute.
    2. Qihui Chen, 2022. "Robust Estimation of Conditional Factor Models," Papers 2204.00801, arXiv.org, revised Apr 2022.

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    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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