A Synthesis of Two Factor Estimation Methods
- 1 April 2015
- journal article
- research article
- Published by Cambridge University Press (CUP) in Journal of Financial and Quantitative Analysis
- Vol. 50 (4) , 825-842
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.Keywords
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