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Faculty of Economics

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Connor, G., Hagmann, M. and Linton, O.

Efficient semiparametric estimation of the Fama–French model and extensions


Vol. 80(2) pp. 713-754 (2012)

Abstract: This paper develops a new estimation procedure for characteristic-based factor models of stock returns. We treat the factor model as a weighted additive nonparametric regression model, with the factor returns serving as time-varying weights and a set of univariate nonparametric functions relating security characteristic to the associated factor betas. We use a time-series and cross-sectional pooled weighted additive nonparametric regression methodology to simultaneously estimate the factor returns and characteristic-beta functions. By avoiding the curse of dimensionality, our methodology allows for a larger number of factors than existing semiparametric methods. We apply the technique to the three-factor Fama–French model, Carhart's four-factor extension of it that adds a momentum factor, and a five-factor extension that adds an own-volatility factor. We find that momentum and own-volatility factors are at least as important, if not more important, than size and value in explaining equity return comovements. We test the multifactor beta pricing theory against a general alternative using a new nonparametric test.

JEL Codes: G12, C14

Author links: Oliver Linton  

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