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Testing conditional factor models: A nonparametric approach

Author

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  • Li, Yan
  • Yang, Liyan
Abstract
Some recent studies of conditional factor models do not specify conditioning information but use data from small windows to estimate the time series of conditional alphas and betas. In this paper, we propose a nonparametric method using an optimal window to estimate time-varying coefficients. In addition, we offer two empirical tests of a conditional factor model. Using our new method, we examine the performance of the conditional CAPM and the conditional Fama–French three-factor model in explaining the return variations of portfolios sorted by size, book-to-market ratios, and past returns, for which recent literature has generated controversial results. We find that, although in general the conditional FF model outperforms the conditional CAPM, both models fail to explain well-known asset-pricing anomalies. Moreover, for both models, the failure is more pronounced for the equally-weighted portfolios than for the value-weighted ones.

Suggested Citation

  • Li, Yan & Yang, Liyan, 2011. "Testing conditional factor models: A nonparametric approach," Journal of Empirical Finance, Elsevier, vol. 18(5), pages 972-992.
    • Handle: RePEc:eee:empfin:v:18:y:2011:i:5:p:972-992
    DOI: 10.1016/j.jempfin.2011.07.004
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    References listed on IDEAS

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    3. Ang, Andrew & Kristensen, Dennis, 2012. "Testing conditional factor models," Journal of Financial Economics, Elsevier, vol. 106(1), pages 132-156.
    4. Jeremy E. Reynolds, 2014. "Prevailing Preferences," ILR Review, Cornell University, ILR School, vol. 67(3), pages 1017-1041, July.
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    6. Yan Li & Liangjun Su & Yuewu Xu, 2015. "A Combined Approach to the Inference of Conditional Factor Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 33(2), pages 203-220, April.
    7. Kinnunen, Jyri, 2014. "Risk-return trade-off and serial correlation: Do volume and volatility matter?," Journal of Financial Markets, Elsevier, vol. 20(C), pages 1-19.
    8. Sainan Jin & Liangjun Su & Yonghui Zhang, 2015. "Nonparametric testing for anomaly effects in empirical asset pricing models," Empirical Economics, Springer, vol. 48(1), pages 9-36, February.
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    10. Corradi, Valentina & Distaso, Walter & Fernandes, Marcelo, 2013. "Conditional alphas and realized betas," Textos para discussão 341, FGV EESP - Escola de Economia de São Paulo, Fundação Getulio Vargas (Brazil).
    11. Асатуров К.Г., 2015. "Динамические Модели Систематического Риска: Сравнение На Примере Индийского Фондового Рынка," Журнал Экономика и математические методы (ЭММ), Центральный Экономико-Математический Институт (ЦЭМИ), vol. 51(4), pages 59-75, октябрь.
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    13. M. V. Esteban & E. Ferreira & S. Orbe-Mandaluniz, 2015. "Nonparametric methods for estimating and testing for constant betas in asset pricing models," Applied Economics, Taylor & Francis Journals, vol. 47(25), pages 2577-2607, May.
    14. Insana, Alessandra, 2022. "Does systematic risk change when markets close? An analysis using stocks’ beta," Economic Modelling, Elsevier, vol. 109(C).
    15. Nieto Domenech, Belén & Orbe Mandaluniz, Susan & Zárraga Alonso, Ainhoa, 2011. "Time-Varying Beta Estimators in the Mexican Emerging Market," BILTOKI 1134-8984, Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística).
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    18. Mehmet Balcilar & Riza Demirer & Festus V. Bekun, 2021. "Flexible Time-Varying Betas in a Novel Mixture Innovation Factor Model with Latent Threshold," Mathematics, MDPI, vol. 9(8), pages 1-20, April.

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    More about this item

    Keywords

    Conditional CAPM; Conditional Fama–French three-factor model; Momentum; Nonparametric method; Size; Value;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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