Testing Conditional Factor Models: A Nonparametric Approach

39 Pages Posted: 13 Apr 2009 Last revised: 21 Apr 2014

See all articles by Yan Li

Yan Li

Temple University - Fox School of Business and Management

Liyan Yang

University of Toronto - Rotman School of Management

Date Written: April 13, 2011

Abstract

Recent studies of conditional factor models do not specify conditioning information but use data from small windows to estimate the time series of conditional alphas and betas. In this paper, we propose a nonparametric method using an optimal window to estimate time-varying coefficients. In addition, we offer two empirical tests of a conditional factor model. Using our new method, we examine the performance of the conditional CAPM and the conditional Fama-French three-factor model in explaining the return variations of portfolios sorted by size, book-to-market ratios, and past returns, for which recent literature has generated controversial results. We find that, although in general the conditional FF model outperforms the conditional CAPM, both models fail to explain well-known asset-pricing anomalies. Moreover, for both models, the failure is more pronounced for the equally-weighted portfolios than for the value-weighted ones.

Keywords: Asset Pricing, Conditional CAPM, Conditional Fama-French Three-Factor Model, Size, Value, Momentum, Nonparametric Method

JEL Classification: G12

Suggested Citation

Li, Yan and Yang, Liyan, Testing Conditional Factor Models: A Nonparametric Approach (April 13, 2011). Journal of Empirical Finance, 2011, 18(5): 972-992, Available at SSRN: https://ssrn.com/abstract=1378682

Yan Li (Contact Author)

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

Liyan Yang

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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