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Econometrics Paper
Semiparametric Estimation of a Characteristic-based Factor Model of Common Stock Returns
Gregory Connor and Oliver Linton
September 2006
Paper No' EM/2006/506:
Full Paper (pdf)

JEL Classification: G12. C14

Tags: characteristic-based factor model; arbitrage pricing theory; kernel estimation; nonparametric estimation.

We introduce an alternative version of the Fama-French three-factor model of stock returns together with a new estimation methodology. We assume that the factor betas in the model are smooth nonlinear functions of observed security characteristics. We develop an estimation procedure that combines nonparametric kernel methods for constructing mimicking portfolios with parametric nonlinear regression to estimate factor returns and factor betas simultaneously. The methodology is applied to US common stocks and the empirical findings compared to those of Fama and French.