Christopher S. Jones

University of Southern California

United States

Personnal website:
Other affiliations:

Christopher S. Jones created these companion sites

Extracting Factors from Heteroskedastic Asset Returns
Abstract
This paper proposes an alternative to the asymptotic principal components procedure of Connor and Korajczyk (Journal of Financial Economics, 1986) that is robust to time series heteroskedasticity in the factor model residuals. The new method is simple to use and requires no assumptions stronger than those made by Connor and Korajczyk. It is demonstrated through simulations and analysis of actual stock market data that allowing heteroskedasticity sometimes improves the quality of the extracted factors quite dramatically. Over the period from 1989 to 1993, for example, a single factor extracted using the Connor and Korajczyk method explains only 8.2% of the variation of the CRSP value-weighted index, while the factor extracted allowing heteroskedasticity explains 57.3%. Accounting for heteroskedasticity is also important for tests of the APT, with p-values sometimes depending strongly on the factor extraction method used.
Jones, S. C., "Extracting Factors from Heteroskedastic Asset Returns", Journal of Financial Economics, 62, 293-325.
Authors: Jones
Coders: Jones
Last update
11/17/2012
Ranking
30
Runs
17
Visits
81