The reduced-rank beta in linear stochastic discount factor models

Yang Sun, Xuan Zhang and Zhekai Zhang

International Review of Financial Analysis, 2022, vol. 84, issue C

Abstract: In a linear stochastic discount factor model, failure of the full-rank conditions affects the standard statistical inference of coefficients. We propose a novel risk measurement, the reduced-rank beta, which is the risk sensitivity to the effective part of factors for the full-rank covariance matrix. Our reduced-rank beta is a generalisation of the standard beta when the full-rank condition is not satisfied. By considering the Fama–French five-factor (FF5) model for the US equity market, the failure of the full-rank condition is found to affect beta estimates. We demonstrate the reduced-rank beta has important empirical implications for model reductions and anomaly explanations.

Keywords: Reduced-rank beta; Stochastic discount factor; Rank condition; Spurious factor; Asset pricing anomaly (search for similar items in EconPapers)
JEL-codes: C5 G12 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:84:y:2022:i:c:s1057521922003714

DOI: 10.1016/j.irfa.2022.102421

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