Adaptive Testing for Alphas in High-dimensional Factor Pricing Models

Qiang Xia; Xianyang Zhang

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arXiv · 2304.06585

Adaptive Testing for Alphas in High-dimensional Factor Pricing Models

Qiang Xia·Xianyang Zhang

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Abstract

This paper proposes a new procedure to validate the multi-factor pricing theory by testing the presence of alpha in linear factor pricing models with a large number of assets. Because the market's inefficient pricing is likely to occur to a small fraction of exceptional assets, we develop a testing procedure that is particularly powerful against sparse signals. Based on the high-dimensional Gaussian approximation theory, we propose a simulation-based approach to approximate the limiting null distribution of the test. Our numerical studies show that the new procedure can deliver a reasonable size and achieve substantial power improvement compared to the existing tests under sparse alternatives, and especially for weak signals.

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Qiang Xia, Xianyang Zhang. 2023-05-22. Adaptive Testing for Alphas in High-dimensional Factor Pricing Models. https://arxiv.org/abs/2304.06585

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