A factor researcher does not begin with a premium. The researcher begins with a pricing
restriction and a portfolio whose return can be put on the right-hand side of a
regression. This topic designs that experiment for a book-to-price characteristic. The
security market line, the classic CAPM tests, and the arbitrage pricing theory already state the models. The notes here state the joint
hypothesis, the split between a time-series intercept and a cross-sectional premium, and
the construction of the mimicking portfolio those tests require.
By the end of this note you should be able to:
- name the three statements an ex post pricing regression tests at once, and say why the market proxy is one of them;
- assign exposures to a time-series pass and prices of risk to a cross-sectional pass, including the effect of an estimated beta;
- build a factor return from a characteristic by a zero-net-investment sort or by a minimum-variance unit-exposure portfolio.
In this lesson
- Contents
- The big picture
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