Multifactor Models and Their Consistency with the APT

55 Pages Posted: 27 May 2016 Last revised: 28 Dec 2019

See all articles by Ilan Cooper

Ilan Cooper

BI Norwegian Business School

Liang Ma

University of South Carolina - Darla Moore School of Business

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Dennis Philip

Durham University - Department of Economics and Finance

Date Written: December 27, 2019

Abstract

We examine the consistency of several prominent multifactor models from the asset pricing literature with the Arbitrage Pricing Theory (APT) framework. We follow the APT-related literature and estimate the common factor structure from a cross-section containing 420 equity portfolios (associated with 42 major CAPM anomalies) by employing the asymptotic principal components method. Our benchmark model contains six statistical factors and clearly dominates (both in economic and statistical terms) most of the empirical multifactor models. These results represent a critical challenge to the current workhorse models in terms of explaining large-scale portfolio equity risk premia and achieving consistency with the APT.

Keywords: asset pricing; linear multifactor models; APT; equity risk factors; stock market anomalies; cross-section of stock returns; principal components

JEL Classification: G10; G12

Suggested Citation

Cooper, Ilan and Ma, Liang and Maio, Paulo F. and Philip, Dennis, Multifactor Models and Their Consistency with the APT (December 27, 2019). Available at SSRN: https://ssrn.com/abstract=2784898 or http://dx.doi.org/10.2139/ssrn.2784898

Ilan Cooper

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Liang Ma

University of South Carolina - Darla Moore School of Business ( email )

1014 Greene Street
Columbia, SC 29208
United States
803-777-6366 (Phone)

HOME PAGE: http://sites.google.com/site/liangmaweb/

Paulo F. Maio (Contact Author)

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki
Finland

HOME PAGE: http://sites.google.com/site/paulofmaio/home

Dennis Philip

Durham University - Department of Economics and Finance ( email )

Department of Economics and Finance
Mill Hill Lane
Durham, DH1 3LB
United Kingdom

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