do idiosyncratic risks in multi-factor asset pricing models really contain a hidden non-diversifiable factor a diagnostic testing approach特质风险在多因素资产定价模型真的包含一个隐藏non-diversifiable因素诊断测试方法.pdfVIP

Journal of Mathematical Finance, 2012, 2, 251-263 /10.4236/jmf.2012.23028 Published Online August 2012 (http://www.SciRP.org/journal/jmf) Do Idiosyncratic Risks in Multi-Factor Asset Pricing Models Really Contain a Hidden Non-Diversifiable Factor? A Diagnostic Testing Approach 1 2 Jau-Lian Jeng , Qingfeng Wilson Liu 1School of Business and Management, Azusa Pacific University, Azusa, USA 2College of Business, James Madison University, Harrisonburg, USA Email: jjeng@, liuqx@ Received May 25, 2012; revised June 28, 2012; accepted July 8, 2012 ABSTRACT This paper employs a new approach to analyze potentially omitted non-diversifiable factors in the idiosyncratic risks from multi-factor asset pricing models. It is shown that if there is an omitted non-diversifiable hidden factor, the idio- syncratic risks will contain persistent cross-sectional memory. An extended Rescaled Variance test generalized from L. Giraitis, P. Kokoszaka, R. Leipus, and G. Teyssiere [1] with finite forecast horizon is provided to investigate the cross-sectional memory of forecast errors in multifactor pricing models. Under the null hypothesis that idiosyncratic risks contain only short memory when there is no hidden non-diversifiable factor, we demonstrate that the extend- edT-sample Rescaled Variance test statistic approximates a functional of weighted Brownian Bridge, which is distrib- uted asymptotically as the T-sample Watson’s statistic presented by Maag [2]. Using this approach, our empirical tests that compare forecast errors from the CAPM and Fama-French [3] model with