A Combined Approach to the Inference of Conditional Factor Models

56 Pages Posted: 20 Dec 2012

See all articles by Yan Li

Yan Li

Temple University - Fox School of Business and Management

Liangjun Su

Singapore Management University - School of Economics

Yuewu Xu

Fordham University - Gabelli School of Business

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Date Written: December 20, 2012

Abstract

This paper develops a new methodology for estimating and testing conditional factor models in finance. We propose a two-stage procedure that naturally unifies the two existing approaches in the finance literature -- the parametric approach and the nonparametric approach. Our combined approach possesses important advantages over both methods. Using our two-stage combined estimator, we derive new test statistics for investigating key hypotheses in the context of conditional factor models. Our tests can be performed on a single asset or jointly across multiple assets. We further propose a novel test to directly check whether the parametric model used in our first stage is correctly specified. In our empirical analysis, we use our new method to examine the performance of the conditional CAPM, which has generated controversial results in the recent asset-pricing literature.

Suggested Citation

Li, Yan and Su, Liangjun and Xu, Yuewu, A Combined Approach to the Inference of Conditional Factor Models (December 20, 2012). Available at SSRN: https://ssrn.com/abstract=2192263 or http://dx.doi.org/10.2139/ssrn.2192263

Yan Li (Contact Author)

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

Philadelphia, PA 19122
United States

Liangjun Su

Singapore Management University - School of Economics ( email )

90 Stamford Road
178903
Singapore

Yuewu Xu

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
New York, NY 10458
United States

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