Abstract
We refine the approximate factor model of asset returns by distinguishing between strong factors, whose sum of squared factor betas grow at the same rate as the number of assets, and semi-strong factors, whose sum of squared factor betas grow to infinity, but at a slower rate. We develop a test statistic for strength of factors based on the cross-sectional mean-square of regression-estimated betas. We also describe an adjusted version of the test statistic to differentiate semi-strong factors from strong factors. We apply the methodology to daily equity returns to characterize some pre-specified factors as strong or semi-strong.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 70-93 |
| Number of pages | 24 |
| Journal | Journal of Financial Econometrics |
| Volume | 22 |
| Issue number | 1 |
| DOIs | |
| State | Published - 2024 |
Funding
We would like to thank Juan Carlos Arismendi-Zambrano, Thomas Flavin, Bartosz Gębka, Oliver Linton, Donal O’Neill, Hashem Pesaran, Anita Suurlaht, Dacheng Xiu, the anonymous referees, and seminar participants at Cambridge University, the Econometric Research in Finance Workshop at the Warsaw School of Economics, and University College Dublin for helpful comments. We would also like to thank Honghao Wang for excellent research assistance. G.C. acknowledges the support of Science Foundation Ireland under Grant Number 16/SPP/3347.
Keywords
- factor model
- semi-strong factors
ASJC Scopus subject areas
- Finance
- Economics and Econometrics