A Synthesis of Two Factor Estimation Methods. (13th November 2015)

• Record Type: Journal Article
• Authors: Connor, Gregory; Korajczyk, Robert A.; Uhlaner, Robert T.
• Is Part Of: Journal of financial and quantitative analysis. Volume 50:Number 4(2016)
• Page Start: 825
• Page End: 842
• Publication Date: 2015-11-13
• Subjects: Finance -- Periodicals; Investments -- Mathematics -- Periodicals; 332.05
• DOI: 10.1017/S0022109015000307
• Languages: English
• ISSNs: 0022-1090

Abstract

Abstract: Two-pass cross-sectional regression (TPCSR) is frequently used in estimating factor risk premia. Recent papers argue that the common practice of grouping assets into portfolios to reduce the errors-in-variables (EIV) problem leads to loss of efficiency and masks potential deviations from asset pricing models. One solution that allows the use of individual assets while overcoming the EIV problem is iterated TPCSR (ITPCSR). ITPCSR converges to a fixed point regardless of the initial factors chosen. ITPCSR is intimately linked to the asymptotic principal components (APC) method of estimating factors since the ITPCSR estimates are the APC estimates, up to a rotation.