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Do Assumptions About Factor Structure Matter in Empirical Tests of the APT?

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  • Ian Garrett
  • Richard Priestley

Abstract

The effect of assumptions about factor structure on empirical tests of multifactor models such as the Arbitrage Pricing Policy Theory has received little attention in the literature. Using data on securities traded on the London Stock Exchange, we examine whether returns are best described by an approximate factor structure and whether assumptions about correlations across idiosyncratic returns have a significant impact on estimated prices of risk and their significance. Our findings suggest that returns are best described by an approximate factor structure and, if this is taken into account when empirically testing the APT, six factors carry significant prices of risk. However, if a strict factor structure is imposed, no factors carry significant prices of risk. These findings suggest that assumptions about factor structure matter in empirically testing the APT.

Suggested Citation

  • Ian Garrett & Richard Priestley, 1997. "Do Assumptions About Factor Structure Matter in Empirical Tests of the APT?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(2), pages 249-260, March.
    • Handle: RePEc:bla:jbfnac:v:24:y:1997:i:2:p:249-260
    DOI: 10.1111/1468-5957.00103
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    Cited by:

    1. Costas M. Stephanou & Gawie S. du Toit & Marius J. Maritz, 2003. "The Release of Nelson Mandela: Effect on the Johannesburg Securities Exchange," Multinational Finance Journal, Multinational Finance Journal, vol. 7(3-4), pages 153-175, September.
    2. Joelle Miffre, 2003. "The cross section of expected futures returns and the Keynesian hypothesis," Applied Financial Economics, Taylor & Francis Journals, vol. 13(10), pages 731-739.

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