A Test for the Number of Factors in an Approximate Factor Model

47 Pages Posted: 24 Jan 2007 Last revised: 21 Aug 2009

Robert A. Korajczyk

Northwestern University - Kellogg School of Management

Gregory Connor

London School of Economics & Political Science (LSE) - Department of Accounting and Finance

Date Written: May 1993

Abstract

An important issue in applications of multifactor models of asset returns is the appropriate number of factors. Most extant tests for the number of factors are valid only for strict factor models, in which diversifiable returns are uncorrelated across assets. In this paper we develop a test statistic to determine the number of factors in an approximate factor model of asset returns, which does not require that diversifiable components of returns be uncorrelated across assets. We find evidence for one to six pervasive factors in the cross-section of New York Stock Exchange and American Stock Exchange stock returns.

Keywords: Factor Models, Principal Components

JEL Classification: G1, G12, C3, C33

Suggested Citation

Korajczyk, Robert A. and Connor, Gregory, A Test for the Number of Factors in an Approximate Factor Model (May 1993). Journal of Finance, Vol. 48, pp. 1263-1291, September 1993. Available at SSRN: https://ssrn.com/abstract=959023

Robert A. Korajczyk (Contact Author)

Northwestern University - Kellogg School of Management ( email )

Kellogg School of Management
2211 Campus Drive, Room 4357
Evanston, IL 60208
United States
847-491-8336 (Phone)
847-491-5719 (Fax)

HOME PAGE: http://www.kellogg.northwestern.edu/faculty/directory/korajczyk_robert.aspx#research

Gregory Connor

London School of Economics & Political Science (LSE) - Department of Accounting and Finance ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44 702 955-6407 (Phone)
+44 702 955-7420 (Fax)

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