A Test for the Number of Factors in an Approximate Factor Model
Robert A. Korajczyk
Northwestern University - Kellogg School of Management
London School of Economics & Political Science (LSE) - Department of Accounting and Finance
Journal of Finance, Vol. 48, pp. 1263-1291, September 1993
An important issue in applications of multifactor models of asset returns is the appropriate number of factors. Most extant tests for the number of factors are valid only for strict factor models, in which diversifiable returns are uncorrelated across assets. In this paper we develop a test statistic to determine the number of factors in an approximate factor model of asset returns, which does not require that diversifiable components of returns be uncorrelated across assets. We find evidence for one to six pervasive factors in the cross-section of New York Stock Exchange and American Stock Exchange stock returns.
Number of Pages in PDF File: 47
Keywords: Factor Models, Principal Components
JEL Classification: G1, G12, C3, C33Accepted Paper Series
Date posted: January 24, 2007 ; Last revised: August 21, 2009
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