Download This PaperA Test for the Number of Factors in an Approximate Factor Model
47 Pages Posted: 24 Jan 2007 Last revised: 21 Aug 2009
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: Suggested Citation
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