Multifactor Models and Their Consistency with the APT
55 Pages Posted: 27 May 2016 Last revised: 28 Dec 2019
Date Written: December 27, 2019
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: Suggested Citation