Factor Representing Portfolios in Large Asset Markets

CEMFI Working Paper No. 0001

67 Pages Posted: 17 Jul 2000

See all articles by Enrique Sentana

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI); Financial Markets Group; Centre for Economic Policy Research (CEPR)

Date Written: January 2000

Abstract

We study the properties of mimicking portfolios in an intertemporal APT model, in which the conditional mean and covariance matrix of returns vary in an interdependent manner. We use a signal extraction approach, and relate the efficiency of (possibly) dynamic basis portfolios to mean square error minimisation. We prove that many portfolios converge to the factors as the number of assets increases, but show that the conditional Kalman filter portfolios are the ones with both minimum tracking error variability, and maximum correlation with the common factors. We also show that our conclusions are unlikely to change when using parameter estimates.

Keywords: Factor models, basis portfolios, APT, Intertermporal Asset Pricing, Kalman Filter

JEL Classification: G11

Suggested Citation

Sentana, Enrique, Factor Representing Portfolios in Large Asset Markets (January 2000). CEMFI Working Paper No. 0001. Available at SSRN: https://ssrn.com/abstract=215668 or http://dx.doi.org/10.2139/ssrn.215668

Enrique Sentana (Contact Author)

Centro de Estudios Monetarios y Financieros (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~sentana/

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Centre for Economic Policy Research (CEPR)

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United Kingdom

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