GMM estimation of the number of latent factors: With application to international stock markets

We propose new generalized method of moments (GMM) estimators for the number of latent factors in linear factor models. The estimators are appropriate for data with a large (small) number of cross-sectional observations and a small (large) number of time series observations. The estimation procedure...

Full description

Saved in:
Bibliographic Details
Published in:Journal of empirical finance 2010-09, Vol.17 (4), p.783-802
Main Authors: Ahn, Seung C., Perez, M. Fabricio
Format: Article
Language:English
Subjects:
Asset pricing
Factor models
Factor models GMM Number of factors International stock market Asset pricing
Generalized method of moments
GMM
International capital market
International stock market
Market analysis
Model testing
Number of factors
Stock exchange
Stock returns
Stockholders
U.S.A
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:We propose new generalized method of moments (GMM) estimators for the number of latent factors in linear factor models. The estimators are appropriate for data with a large (small) number of cross-sectional observations and a small (large) number of time series observations. The estimation procedure is simple and robust to the configurations of idiosyncratic errors encountered in practice. In addition, the method can be used to evaluate the validity of observable candidate factors. Monte Carlo experiments show that the proposed estimators have good finite-sample properties. Applying the estimators to international stock markets, we find that international stock returns are explained by one strong global factor. This factor is highly correlated with the Fama–French factors from the U.S. stock market. This result can be interpreted as evidence of market integration. We also find two weak factors closely related to markets in Europe and the Americas, respectively.
ISSN:0927-5398
1879-1727
DOI:10.1016/j.jempfin.2010.04.005