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Testing Factor Models in the Cross-Section

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  • Hollstein, Fabian
  • Prokopczuk, Marcel

Abstract

The standard full-sample time-series asset pricing test suffers from poor statistical properties, look-ahead bias, constant-beta assumptions, and rejects models when average factor returns deviate from risk premia. We therefore confront prominent equity pricing models with the classical Fama and MacBeth (1973) cross-sectional test. For all models, we uncover three main findings: (i) the intercept coefficients are economically large and highly statistically significant; (ii) cross-sectional factor risk premium estimates are generally far below the average factor excess returns; and (iii) they are usually not statistically significant. Overall, all new factor models are inconsistent with no-arbitrage pricing and cannot accurately explain the cross-section of stock returns.

Suggested Citation

  • Hollstein, Fabian & Prokopczuk, Marcel, 2022. "Testing Factor Models in the Cross-Section," Journal of Banking & Finance, Elsevier, vol. 145(C).
    • Handle: RePEc:eee:jbfina:v:145:y:2022:i:c:s0378426622002060
    DOI: 10.1016/j.jbankfin.2022.106626
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    More about this item

    Keywords

    Factor models; cross-sectional tests; no-arbitrage pricing; beta estimation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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