Multifactor Models and Their Consistency with the APT

Review of Asset Pricing Studies (forthcoming)

51 Pages Posted: 27 May 2016 Last revised: 31 Dec 2020

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 30, 2020

Abstract

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

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

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 30, 2020). Review of Asset Pricing Studies (forthcoming), 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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