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A Synthesis of Two Factor Estimation Methods

Published online by Cambridge University Press:  13 November 2015

Gregory Connor ,
Robert A. Korajczyk  and
Robert T. Uhlaner
Gregory Connor
Affiliation:
gregory.connor@nuim.ie, Department of Economics, Finance and Accounting, National University of Ireland, Maynooth County Kildare, Ireland
Robert A. Korajczyk*
Affiliation:
r-korajczyk@kellogg.northwestern.edu, Kellogg School of Management, Northwestern University, Evanston, IL 60208, USA
Robert T. Uhlaner
Affiliation:
robert_uhlaner@mckinsey.com, McKinsey & Co., San Francisco, CA 94104, USA.
*
*Corresponding author: r-korajczyk@kellogg.northwestern.edu
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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.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 50 , Issue 4 , August 2015 , pp. 825 - 842
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2015 

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