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Mimicking Portfolios, Economic Risk Premia, and Tests of Multi-Beta Models

Mimicking Portfolios, Economic Risk Premia, and Tests of Multi-Beta Models We consider two formulations of the linear factor model (LFM) with nontraded factors. In the first formulation, LFM, risk premia and alphas are estimated by a cross-sectional regression of average returns on betas. In the second formulation, LFM**, the factors are replaced by their projections on the span of excess returns, and risk premia and alphas are estimated by time series regressions. We compare the two formulations and study the small-sample properties of estimates and test statistics. We conclude that the LFM** formulation should be considered in addition to, or even instead of, the more traditional LFM formulation. For corrected versions of Tables 2, 6, and 7, please see the supplemental files posted with this article. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Business & Economic Statistics Taylor & Francis

Mimicking Portfolios, Economic Risk Premia, and Tests of Multi-Beta Models

15 pages

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References (56)

Publisher
Taylor & Francis
Copyright
© American Statistical Association
ISSN
1537-2707
eISSN
0735-0015
DOI
10.1198/073500108000000042
Publisher site
See Article on Publisher Site

Abstract

We consider two formulations of the linear factor model (LFM) with nontraded factors. In the first formulation, LFM, risk premia and alphas are estimated by a cross-sectional regression of average returns on betas. In the second formulation, LFM**, the factors are replaced by their projections on the span of excess returns, and risk premia and alphas are estimated by time series regressions. We compare the two formulations and study the small-sample properties of estimates and test statistics. We conclude that the LFM** formulation should be considered in addition to, or even instead of, the more traditional LFM formulation. For corrected versions of Tables 2, 6, and 7, please see the supplemental files posted with this article.

Journal

Journal of Business & Economic StatisticsTaylor & Francis

Published: Jul 1, 2008

Keywords: Mimicking portfolios; Economic risk premia; Linear factor models

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