Fundamental properties of linear factor models

Damir Filipovic and Paul Schneider

Papers from arXiv.org

Abstract: We study conditional linear factor models in the context of asset pricing panels. Our analysis focuses on conditional means and covariances to characterize the cross-sectional and inter-temporal properties of returns and factors as well as their interrelationships. We also review the conditions outlined in Kozak and Nagel (2024) and show how the conditional mean-variance efficient portfolio of an unbalanced panel can be spanned by low-dimensional factor portfolios, even without assuming invertibility of the conditional covariance matrices. Our analysis provides a comprehensive foundation for the specification and estimation of conditional linear factor models.

Date: 2024-09, Revised 2025-02
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