New Factor Models and the APT

57 Pages Posted: 12 Dec 2016 Last revised: 19 Jul 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

Multiple version iconThere are 2 versions of this paper

Date Written: July 18, 2019

Abstract

We examine the consistency of the existing multifactor models in the 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 (APC) method. Our model contains six statistical factors from the first nine estimated APCs associated with this cross-section. The model successfully prices the 42 anomalies, with cross-sectional explanatory ratios around or above 50%. Critically, our benchmark statistical model clearly dominates most of the current multifactor models, which implies that most of these models are not good empirical proxies for an APT-based model. The sole exception to this pattern is the five-factor model of Hou, Mo, Xue, and Zhang (2019), which is equivalent (in statistical terms) to our benchmark model. Our results represent a major challenge to most current multifactor models.

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, New Factor Models and the APT (July 18, 2019). Available at SSRN: https://ssrn.com/abstract=2883765 or http://dx.doi.org/10.2139/ssrn.2883765

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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