High-Dimensional Estimation, Basis Assets, and the Adaptive Multi-Factor Model

The Quarterly Journal of Finance, Vol. 10, No. 4 (2020) 2050017 (52 pages), World Scientific Publishing Company and Midwest Finance Association. DOI: 10.1142/S2010139220500172.

49 Pages Posted: 21 May 2018 Last revised: 26 Apr 2021

See all articles by Liao Zhu

Liao Zhu

Cornell University - Department of Statistics and Data Science

Sumanta Basu

Cornell University - Department of Statistical Science

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Martin T. Wells

Cornell University - Law School

Date Written: November 5, 2020

Abstract

The paper proposes a new algorithm for the high-dimensional financial data -- the Groupwise Interpretable Basis Selection (GIBS) algorithm, to estimate a new Adaptive Multi-Factor (AMF) asset pricing model, implied by the recently developed Generalized Arbitrage Pricing Theory, which relaxes the convention that the number of risk-factors is small. We first obtain an adaptive collection of basis assets and then simultaneously test which basis assets correspond to which securities, using high-dimensional methods. The AMF model, along with the GIBS algorithm, is shown to have a significantly better fitting and prediction power than the Fama-French 5-factor model.

Keywords: Asset pricing models, AMF model, GIBS algorithm, high-dimensional statistics, machine learning

JEL Classification: C10, G10

Suggested Citation

Zhu, Liao and Basu, Sumanta and Jarrow, Robert A. and Wells, Martin T., High-Dimensional Estimation, Basis Assets, and the Adaptive Multi-Factor Model (November 5, 2020). The Quarterly Journal of Finance, Vol. 10, No. 4 (2020) 2050017 (52 pages), World Scientific Publishing Company and Midwest Finance Association. DOI: 10.1142/S2010139220500172., Available at SSRN: https://ssrn.com/abstract=3169905 or http://dx.doi.org/10.2139/ssrn.3169905

Liao Zhu (Contact Author)

Cornell University - Department of Statistics and Data Science ( email )

301 Tower Road
Ithaca, NY 14853-3801
United States
607-379-7330 (Phone)

Sumanta Basu

Cornell University - Department of Statistical Science ( email )

1198 Comstock Hall
Ithaca, NY 14853-3801
United States

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Martin T. Wells

Cornell University - Law School ( email )

Comstock Hall
Ithaca, NY 14853
United States
607-255-8801 (Phone)

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