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A Multivariate Test of an Equilibrium APT with Time Varying Risk Premia in the Australian Equity Market
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Robert W. Faff
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Abstract
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This paper applies an asymptotic principal components technique, developed by Connor and Korajczyk (1988), to test an equilibrium version of the Arbitrage Pricing Theory (APT), which permits time varying risk premia, using Australian equity data. Cross-equation restrictions imposed by the APT on a multivariate regression of excess returns on derived factors are tested. Both one-step and iterative versions of the technique are used and results are compared to the capital asset pricing model (CAPM). While the APT appears to perform better than the CAPM, neither model can adequately explain monthly seasonal mispricing in Australian equities.
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Keywords
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ARBITRAGE PRICING THEORY; TIME VARYING RISK PREMIA; ASYMPTOTIC PRINCIPAL COMPONENTS.
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Contact Details
Robert W. Faff
Department of Accounting and Finance
Monash University
Clayton VIC 3168
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The author wishes to thank the seminar participants at Monash University and the Australian Graduate School of Management, University of NSW. Particular appreciation is due to Tim Brailsford, Justin Wood and two anonymous referees. Support provided by the Centre for Research in Accounting and Finance and the research assistance of Shih Thin Wong are also gratefully acknowledged. The author is grateful to Tim Brailsford for providing a series of Thirteen Week Treasury Notes.
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