A Synthesis of Two Factor Estimation Methods

42 Pages Posted: 21 Aug 2009 Last revised: 14 Nov 2015

See all articles by Gregory Connor

Gregory Connor

London School of Economics & Political Science (LSE) - Department of Accounting and Finance

Robert A. Korajczyk

Northwestern University

Robert T. Uhlaner

McKinsey & Co. Inc. - San Francisco Office

Date Written: August 6, 2015

Abstract

Two-pass cross sectional regression (TPCSR) is frequently used in estimating factor risk premiums. Recent papers argue that the common practice of grouping assets into portfolios to reduce the errors-in-variables (EIV) problem leads to loss of efficiency and masks potential deviations from asset pricing models. One solution that allows the use of individual assets while overcoming the EIV problem is iterated TPCSR (ITPCSR). ITSCSR converges to a fixed point regardless of the initial factors chosen. ITPCSR is intimately linked to the asymptotic principal components (APC) method of estimating factors since the ITPCSR estimates are the APC estimates, up to a rotation.

Keywords: Cross-sectional regression, Factor model, Principal components, Errors in variables

JEL Classification: G1, G12, C3

Suggested Citation

Connor, Gregory and Korajczyk, Robert A. and Uhlaner, Robert T., A Synthesis of Two Factor Estimation Methods (August 6, 2015). Journal of Financial and Quantitative Analysis (JFQA), Vol. 50, No. 4, 2015, Available at SSRN: https://ssrn.com/abstract=1452864 or http://dx.doi.org/10.2139/ssrn.1452864

Gregory Connor

London School of Economics & Political Science (LSE) - Department of Accounting and Finance ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 702 955-6407 (Phone)
+44 702 955-7420 (Fax)

Robert A. Korajczyk (Contact Author)

Northwestern University ( email )

Kellogg School of Management
2211 Campus Drive, Room 4357
Evanston, IL 60208-0898
United States
847-491-8336 (Phone)
847-491-7781 (Fax)

HOME PAGE: http://www.kellogg.northwestern.edu/faculty/directory/korajczyk_robert.aspx#research

Robert T. Uhlaner

McKinsey & Co. Inc. - San Francisco Office ( email )

555 California Street
San Francisco, CA 94104
United States
425-981-0250 (Phone)

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