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Notes on Dynamic Factor Pricing Models

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  • Bruce N. Lehmann

Abstract

These notes discuss three aspects of dynamic factor pricing (i.e., APT) models. The first one is that diversifiable idiosyncratic risk is unpredictable in a no-arbitrage world. The second feature is that the conditional factor loadings or betas on the common factors are approximately constant when returns follow an unconditional factor structure. The third topic concerns the estimation of dynamic factor pricing models in large cross-sections when returns follow an unconditional factor structure. These results aid in the interpretation of existing applications and identify some of the issues in the formulation and estimation of dynamic factor pricing models.

Suggested Citation

  • Bruce N. Lehmann, 1991. "Notes on Dynamic Factor Pricing Models," NBER Working Papers 3677, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3677
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    References listed on IDEAS

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    1. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, vol. 18(2), pages 373-399, June.
    2. Stephen A. Ross, 2013. "The Arbitrage Theory of Capital Asset Pricing," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 1, pages 11-30, World Scientific Publishing Co. Pte. Ltd..
    3. Gibbons, Michael R. & Ferson, Wayne, 1985. "Testing asset pricing models with changing expectations and an unobservable market portfolio," Journal of Financial Economics, Elsevier, vol. 14(2), pages 217-236, June.
    4. repec:bla:jfinan:v:44:y:1989:i:5:p:1191-1217 is not listed on IDEAS
    5. Chen, Nai-fu, 1983. "Some Empirical Tests of the Theory of Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 38(5), pages 1393-1414, December.
    6. Connor, Gregory & Korajczyk, Robert A., 1988. "Risk and return in an equilibrium APT : Application of a new test methodology," Journal of Financial Economics, Elsevier, vol. 21(2), pages 255-289, September.
    7. Gur Huberman, 2005. "A Simple Approach to Arbitrage Pricing Theory," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 9, pages 289-308, World Scientific Publishing Co. Pte. Ltd..
    8. Ingersoll, Jonathan E, Jr, 1984. "Some Results in the Theory of Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 39(4), pages 1021-1039, September.
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    Cited by:

    1. Sentana, Enrique, 2004. "Factor representing portfolios in large asset markets," Journal of Econometrics, Elsevier, vol. 119(2), pages 257-289, April.
    2. Bruce N. Lehmann & David M. Modest, 2003. "Diversification and the Optimal Construction of Basis Portfolios," NBER Working Papers 9461, National Bureau of Economic Research, Inc.

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