Dong, C. and Li, S.
Specification Lasso and an Application in Financial Markets
CWPE2139
Abstract: This paper proposes the method of Specification-LASSO in a flexible semi-parametric regression model that allows for the interactive effects between different covariates. Specification-LASSO extends LASSO and Adaptive Group LASSO to achieve both relevant variable selection and model specification. Specification-LASSO also gives preliminary estimates that facilitate the estimation of the regression model. Monte Carlo simulations show that the Specification-LASSO can accurately specify partially linear additive models with interactive regressors. Finally, the proposed methods are applied in an empirical study, which examines the topic proposed by Freyberger et al. (2020), which argues that firms’ sizes may have interactive effects with other security-specific characteristics, which can explain the stocks excess returns together.
Keywords: Variable Selection, Model Selection, Interaction
JEL Codes: C14 G12
Author links:
PDF: https://www.econ.cam.ac.uk/research-files/repec/cam/pdf/cwpe2139.pdf 
Open Access Link: https://doi.org/10.17863/CAM.70001
