Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/161871
Authors: 
Pesaran, M. Hashem
Yamagata, Takashi
Year of Publication: 
2017
Series/Report no.: 
CESifo Working Paper 6432
Abstract: 
This paper proposes a novel test of zero pricing errors for the linear factor pricing model when the number of securities, N, can be large relative to the time dimension, T, of the return series. The test is based on Student t tests of individual securities and has a number of advantages over the existing standardised Wald type tests. It allows for non-Gaussianity and general forms of weakly cross correlated errors. It does not require estimation of an invertible error covariance matrix, it is much faster to implement, and is valid even if N is much larger than T. Monte Carlo evidence shows that the proposed test performs remarkably well even when T = 60 and N = 5;000. The test is applied to monthly returns on securities in the S&P 500 at the end of each month in real time, using rolling windows of size 60. Statistically significant evidence against Sharpe-Lintner CAPM and Fama-French three factor models are found mainly during the recent financial crisis. Also we find a significant negative correlation between a twelve-months moving average p-values of the test and excess returns of long/short equity strategies (relative to the return on S&P 500) over the period November 1994 to June 2015, suggesting that abnormal profits are earned during episodes of market inefficiencies.
Subjects: 
CAPM
testing for alpha
weak and spatial error cross-sectional dependence
S&P 500 securities
long/short equity strategy
JEL: 
C12
C15
C23
G11
G12
Document Type: 
Working Paper

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