Notes on Dynamic Factor Pricing Models

22 Pages Posted: 21 Jul 2010 Last revised: 21 Jul 2022

See all articles by Bruce N. Lehmann

Bruce N. Lehmann

University of California, San Diego; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT)

Date Written: April 1991

Abstract

These notes discuss three aspects of dynamic factor pricing (i.e., APT) models. The first one is that diversifiable idiosyncratic risk is unpredictable in a no-arbitrage world. The second feature is that the conditional factor loadings or betas on the common factors are approximately constant when returns follow an unconditional factor structure. The third topic concerns the estimation of dynamic factor pricing models in large cross-sections when returns follow an unconditional factor structure. These results aid in the interpretation of existing applications and identify some of the issues in the formulation and estimation of dynamic factor pricing models.

Suggested Citation

Lehmann, Bruce, Notes on Dynamic Factor Pricing Models (April 1991). NBER Working Paper No. w3677, Available at SSRN: https://ssrn.com/abstract=1646204

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