Adaptive Testing for Alphas in High-Dimensional Factor Pricing Models

Qiang Xia and Xianyang Zhang

Journal of Business & Economic Statistics, 2024, vol. 42, issue 2, 640-653

Abstract: This article proposes a new procedure to validate the multi-factor pricing theory by testing the presence of alpha in linear factor pricing models with a large number of assets. Because the market’s inefficient pricing is likely to occur to a small fraction of exceptional assets, we develop a testing procedure that is particularly powerful against sparse signals. Based on the high-dimensional Gaussian approximation theory, we propose a simulation-based approach to approximate the limiting null distribution of the test. Our numerical studies show that the new procedure can deliver a reasonable size and achieve substantial power improvement compared to the existing tests under sparse alternatives, and especially for weak signals.

Date: 2024
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DOI: 10.1080/07350015.2023.2217871

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