Factor Sufficiency in Asset Pricing: An Application for the Brazilian Market

Rafaela Dezidério dos Santos Rocha and Márcio Laurini
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Rafaela Dezidério dos Santos Rocha: Department of Economics, FEARP-University of São Paulo, Ribeirão Preto 14040-905, Brazil

IJFS, 2023, vol. 11, issue 4, 1-31

Abstract: The multifactor asset pricing model derived from the Fama–French approach is extensively used in asset risk premium estimation procedures. Even including a considerable number of factors, it is still possible that omitted factors affect the estimation of this model. In this work, we compare estimators robust to the presence of omitted factors in estimating the risk premium in the Brazilian market. Initially, we analyze the panel of asset returns using the mean group and common correlated effect estimators to detect the presence of omitted factors. We then compare the results with those obtained by a estimator robust to omitted variables, which uses a principal components approach to correct the estimation in the case of the omission of latent factors. We conclude that there is evidence of omitted factors, and the best predictor for the expect returns is the common correlated effects estimator.

Keywords: robust estimation; risk premia; asset pricing; mis-specification (search for similar items in EconPapers)
JEL-codes: F2 F3 F41 F42 G1 G2 G3 (search for similar items in EconPapers)
Date: 2023
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