A Combined Approach to the Inference of Conditional Factor Models

47 Pages Posted: 28 Jun 2014

See all articles by Yan Li

Yan Li

Temple University - Fox School of Business and Management

Liangjun Su

Singapore Management University

Yuewu Xu

Fordham University - Gabelli School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 3, 2014

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. Simulations indicate that our estimates and tests perform well in finite samples. 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.

Keywords: Conditional Factor Models, Specification Tests, Semiparametric Method, Nonparametric Method, Conditional CAPM

JEL Classification: C51, C52, G12

Suggested Citation

Li, Yan and Su, Liangjun and Xu, Yuewu, A Combined Approach to the Inference of Conditional Factor Models (May 3, 2014). Available at SSRN: https://ssrn.com/abstract=2459487 or http://dx.doi.org/10.2139/ssrn.2459487

Yan Li

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

Philadelphia, PA 19122
United States

Liangjun Su (Contact Author)

Singapore Management University ( 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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