Two-pass tests of asset pricing models with useless factors

Authors
Citation
R. Kan et C. Zhang, Two-pass tests of asset pricing models with useless factors, J FINANCE, 54(1), 1999, pp. 203-235
Citations number
30
Categorie Soggetti
Economics
Journal title
JOURNAL OF FINANCE
ISSN journal
00221082 → ACNP
Volume
54
Issue
1
Year of publication
1999
Pages
203 - 235
Database
ISI
SICI code
0022-1082(199902)54:1<203:TTOAPM>2.0.ZU;2-5
Abstract
In this paper we investigate the properties of the standard two-pass method ology of testing beta pricing models with misspecified factors. In a settin g where a factor is useless, defined as being independent of all the asset returns, we provide theoretical results and simulation evidence that the se cond-pass cross-sectional regression tends to find the beta risk of the use less factor priced more often than it should. More surprisingly, this missp ecification bias exacerbates when the number of time series observations in creases. Possible ways of detecting useless factors are also examined.