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Fundamental properties of linear factor models

Author

Listed:
  • Damir Filipović

    (École Polytechnique Fédérale de Lausanne; Swiss Finance Institute)

  • Paul Schneider

    (University of Lugano - Institute of Finance; Swiss Finance Institute)

Abstract

In this short note, we study conditional linear factor models in the context of asset pricing panels. Our analysis focuses on conditional means and covariances to characterize the cross-sectional and inter-temporal properties of returns and factors as well as their interrelationships. We also review the conditions outlined in Kozak and Nagel (2024) and show how the conditional mean-variance efficient portfolio of an unbalanced panel can be spanned by low-dimensional factor portfolios, even without assuming invertibility of the conditional covariance matrices. Our analysis provides a comprehensive foundation for the specification and estimation of conditional linear factor models.

Suggested Citation

  • Damir Filipović & Paul Schneider, 2024. "Fundamental properties of linear factor models," Swiss Finance Institute Research Paper Series 24-42, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp2442
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    More about this item

    Keywords

    asset pricing; factor models; characteristics; covariances; meanvariance efficient portfolio; stochastic discount factor; covariance estimation;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis

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