Testing conditional factor models: A nonparametric approach |
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Authors: | Yan Li Liyan Yang |
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Institution: | a Department of Finance, Fox School of Business, Temple University, 1801 Liacouras Walk, Philadelphia, PA 19122, United Statesb Rotman School of Management, University of Toronto, 105 St. George Street, ON, Canada M5S 3E6 |
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Abstract: | Some recent studies of conditional factor models do not specify conditioning information but use data from small windows to estimate the time series of conditional alphas and betas. In this paper, we propose a nonparametric method using an optimal window to estimate time-varying coefficients. In addition, we offer two empirical tests of a conditional factor model. Using our new method, we examine the performance of the conditional CAPM and the conditional Fama-French three-factor model in explaining the return variations of portfolios sorted by size, book-to-market ratios, and past returns, for which recent literature has generated controversial results. We find that, although in general the conditional FF model outperforms the conditional CAPM, both models fail to explain well-known asset-pricing anomalies. Moreover, for both models, the failure is more pronounced for the equally-weighted portfolios than for the value-weighted ones. |
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Keywords: | G10 G11 G12 |
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