Please use this identifier to cite or link to this item:
http://hdl.handle.net/11375/21029
Title: | Arbitrage pricing restrictions and the predictability of stock returns by statistical factor analysis |
Authors: | Balvers, Ronald J. Stivers, Adam Michael Lee-Chin & Family Institute for Strategic Business Studies |
Department: | None |
Keywords: | Asset pricing;Arbitrage pricing;Factor analysis;Hedging |
Publication Date: | Sep-2016 |
Series/Report no.: | Michael Lee-Chin & Family Institute for Strategic Business Studies Working Paper ; 2016-04 |
Abstract: | In standard principal components estimation of the APT, the factors are obtained without employing the restrictions on mean returns implied by the APT. We modify the principal components methodology to allow mean returns to reflect the theoretical restrictions up to any level of accuracy and generate optimal constrained APT factors from the eigenvectors of a suitably modified covariance matrix. With the 30 industry portfolios as test assets, the resulting risk factors predict returns hedged for systematic risk better out of sample than the standard CAPM, Fama-French, and Carhart asset pricing models and better than conventional principal component factors. Valuation Insight: The technical approach developed in this paper allows for a better estimate of the proper cost of capital to be used in valuation. By incorporating restrictions implied by arbitrage, the revised estimates of the cost of capital are empirically better in the sense of forecasting out of sample the returns of the firm to be valued. |
Description: | 46 p. ; Includes bibliographical references (pp. 31-35). ; "September 21, 2016." We thank workshop participants at McMaster University for valuable comments. |
URI: | http://hdl.handle.net/11375/21029 |
Appears in Collections: | Michael Lee-Chin & Family Institute for Strategic Business Studies Working Paper Series |
Files in This Item:
File | Description | Size | Format | |
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sbv_wp_2016-04.pdf | 298.44 kB | Adobe PDF | View/Open |
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