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Bank Testing Linear Factor Pricing Models with Large Cross-Sections: A Distribution-Free Approach

Sermin Gungor and Richard Luger

Staff Working Papers from Bank of Canada

Abstract: We develop a finite-sample procedure to test the beta-pricing representation of linear factor pricing models that is applicable even if the number of test assets is greater than the length of the time series. Our distribution-free framework leaves open the possibility of unknown forms of non-normalities, heteroskedasticity, time-varying correlations, and even outliers in the asset returns. The power of the proposed test procedure increases as the time-series lengthens and/or the cross-section becomes larger. This stands in sharp contrast to the usual tests that lose power or may not even be computable if the cross-section is too large. Finally, we revisit the CAPM and the Fama-French three factor model. Our results strongly support the mean-variance efficiency of the market portfolio.

Keywords: Econometric and statistical methods; Financial markets (search for similar items in EconPapers)
JEL-codes: C12 C14 C33 G11 G12 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2010
New Economics Papers: this item is included in nep-ban and nep-ecm
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