New Factor Models and the APT
54 Pages Posted: 1 Oct 2018
Date Written: August 30, 2018
Abstract
We seek to describe the cross-section of stock returns. We follow the APT literature and estimate the common factor structure among a cross-section containing 420 portfolios (associated with 42 anomalies). Our statistical model contains nine common factors and (by construction) prices well both the original returns and an efficient combination of these returns. This model clearly outperforms the empirical workhorses in the literature when it comes to pricing risk premia. Augmenting the empirical models with new factor-mimicking portfolios, based on APT principles (strong time-series correlation with testing portfolios), significantly improves their performance (with gains in R2 above 30 percentage points).
Keywords: asset pricing; linear multifactor models; APT; equity risk factors; stock market anomalies; cross-section of stock returns; principal components
JEL Classification: G10, G12
Suggested Citation: Suggested Citation