4

A Multivariate Test of an Equilibrium APT with Time Varying Risk Premia in the Australian Equity Market
by Robert W. Faff
Abstract: 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. Keywords:
ARBITRAGE PRICING THEORY; TIME VARYING RISK PREMIA; ASYMPTOTIC PRINCIPAL COMPONENTS. Department of Accounting and Finance, Monash University, Clayton VIC 3168.
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 Note rates.
Australian Journal of Management, 17, 2, December 1992, The University of New South Wales

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1. Introduction he Arbitrage Pricing Theory developed by Ross (1976) relies on two basic assumptions: (a) that returns are generated by a k-factor process; and, (b) that any investment involving zero risk and zero net wealth will produce zero returns. The consequent pricing theory states that k-factor sensitivities are linearly related to expected returns. Empirical tests of the APT have supported anything up to five priced factors. Initial work by Roll and Ross (1980) suggested the possible pricing of three or four factors in the United States, while Australian evidence produced by Faff (1988) indicated a three-factor model. The work of Faff (1988) provides an initial attempt at testing the APT using Australian data. Several limitations of that study can be identified, which involve the issues of nonstationarity, errors-in-variables (EIV), and seasonality in monthly return. First, tests that involve averaging over long time-series assume that the underlying economic parameters being estimated remain constant over the period examined. A period of twelve years was examined by Faff (1988), which is excessive relative to the standard five-year analysis commonly employed in most asset pricing tests.1 Second, the two-stage testing procedure employed suffers from the well known errors-in-variables problem.2 A final drawback of the crosssectional testing framework used by Faff (1988) is an inability to incorporate the monthly seasonality in Australian equity returns as documented by Brown, Keim, Kleidon and Marsh (1983) and Wood (1990a). Connor and Korajczyk (1986, 1988) developed an asymptotic principal components technique, which presents a framework able to overcome these difficulties. The two most notable features which distinguish it from the technique used by Faff (1988) are, first, that it permits factor risk premiums to vary over time, and, second, that it involves a principal components analysis of the timeseries cross-product matrix (rather than the cross-sectional variance-covariance matrix) of returns. An important consequence of these features is that the common empirical concern of nonstationarity is greatly diminished. In standard frameworks for testing asset pricing models [for example, in Faff (1988)] the risk measure(s) and the factor risk premium(s) are all assumed to be constant over a given period of investigation. In the framework developed by Connor and Korajczyk (1988), however, only the factor risks are assumed to be constant. Moreover, their framework makes it feasible to assume that factor risks are constant over much shorter periods of analysis, for example, five years.
_ ____________ 1. A period of twelve years was necessary in order to maintain sufficient degrees of freedom, that is, the number of companies included had to exceed the number of time-series observations. See Faff (1988, p.30). 2. In the first stage, a principal components analysis of the cross-sectional variance-covariance matrix of returns provides the estimated (APT) factor loadings. These are then employed as the independent variables (measured with error) in a cross-sectional regression, with the sample mean return across assets as the dependent variable.

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Connor and Korajczyk (1988) conducted several multivariate tests of crossequation restrictions imposed by the APT using U.S. monthly data. They examined four non-overlapping five-year subperiods from 1964 to 1983. Generally, they found that a five-factor version of the APT was able to explain the January/size effect that is well documented in previous U.S. research. They attributed this success to seasonality in the estimated risk premiums of the multi-factor model that is not captured by the single-factor CAPM (Connor and Korajczyk 1988, p.288). But it was found that the APT cannot explain non-January specific mispricing. Consequently, they concluded that while neither the CAPM nor the APT are perfect models, their evidence suggests the APT is a reasonable empirical alternative. Connor and Korajczyk (1988) recognised that in some cases the crosssectional size available may not be sufficiently large to ensure that the best possible estimate is obtained from the initial one-step procedure. In these circumstances they suggest an iterative variant that is more efficient. This iterative procedure involves scaling excess returns according to the estimated standard deviation of idiosyncratic returns. The cross-sectional sample size available to Connor and Korajczyk (1988) was very large and consequently they found, in their application, that the iterative procedure did not provide much improvement over the one-step procedure. But they recognised that applications with smaller cross-sectional samples may find greater improvement (Connor and Korajczyk 1988, p.260). Given the relatively small number of firms available in an Australian application, it is quite possible that the iterative estimates will produce a nontrivial improvement. Consequently, this paper explores the sensitivity of results using the one-step versus the iterative version of the asymptotic principal components procedure. The aim of this paper is to extend and improve on the empirical examination of the APT in Faff (1988) by applying a methodology developed by Connor and Korajczyk (1988) which: (a) is feasible with relatively small subperiods; (b) uses a multivariate approach; (c) permits time varying factor risk premiums; and, (d) incorporates monthly seasonality effects. The structure of this paper is as follows. In Section 2 the asymptotic principal components technique of Connor and Korajczyk (1988), as applied here, is reviewed. Section 3 presents the multivariate methodology upon which the tests are performed. In Section 4 the data set is described and related issues are discussed. The penultimate section details the results obtained, while the final section provides a summary and conclusion. 2. Arbitrage Pricing and Asymptotic Principal Components 2.1 An Empirical Specication of the APT onnor and Korajczyk (1988) present an empirical specification of the APT which integrates the assumed factor model generating returns with an equilibrium version of the APT asset pricing equation. Specifically, the underlying - 235 -

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k-factor model generating returns is assumed to be: Rit = E (Rit ) + B 1i f 1t + B 2i f 2t + . . . + Bki fkt + it . i = 1, . . . , N assets, and t = 1, . . . , T time periods, where: Rit E (Rit ) B ji f jt
it

(1)

= = = =

the return on asset i in period t ; the expected return on asset i in period t ; the jth factor sensitivity for asset i, j = 1, . . . , k ; the realisation of the jth factor in period t, j = 1, . . . , k ; and, = the idiosyncratic return for asset i in period t.

Further, if a risk-free asset exists then the equilibrium version of the APT is given by: E (Rit ) = RFt + B 1i 1t + B 2i 2t + . . . + Bki kt , where: RFt = the return on the risk-free asset in period t ; and, jt = the realised risk premium for factor j in period t. Upon substitution of Equation 2 into Equation 1, and rearranging, the empirical specification of the APT in excess returns form becomes: rit = B 1i F 1t + B 2i F 2t + . . . + Bki Fkt + it , where: rit = (Rit RFt ), that is, the excess return for asset i in period t ; and, F jt = ( jt + f jt ) j = 1, . . . , k, that is, the realised risk premium plus the factor realisation for factor j in period t. (3) (2)

The focus of the empirical tests which follow is primarily on the empirical specification of the APT given in Equation 3. This formulation incorporates factor risk premium information ( jt ) through the F jt variables and these are not restricted in their time-series properties. It is in this sense that Connor and Korajczyk (1988) state that their framework is valid for models with time variation in factor risk premiums. The reader should note, however, that this framework does not permit the separate identification of the factor risk premiums ( jt ) from the associated factor realisations ( f jt ). 2.2 Asymptotic Principal Components: One Step and Iterative Versions The asymptotic principal components technique was initially developed by Connor and Korajczyk (1986). It is similar to standard principal components3 except that

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it analyses the time-series cross-product matrix of excess returns as opposed to the cross-sectional variance-covariance matrix of returns. Its asymptotic nature relates to its reliance on statistical approximations which are valid as the number of cross-sectional observations grow large (Connor and Korajczyk 1986, p.381). Connor and Korajczyk (1986) showed that the first k eigenvectors of the crossproduct matrix are approximately (asymptotically) non-singular linear transformations of the true F jt variables in Equation 3.4 A drawback of this one-step technique is that there is no objective means of assessing whether a given cross-sectional sample is sufficiently large so as to justify the asymptotic nature of the procedure. But Connor and Korajczyk (1988, pp.259261) provided an iterative refinement of the technique which promised improved estimation efficiency in smaller samples. The iterative process is as follows. a. Form the cross-product matrix () of excess returns. b. Calculate the eigenvectors for the cross-product matrix. The first k eigenvectors represent proxies for the independent variables in Equation 3.

c. For each individual asset in the sample run a regression of excess returns on the first k eigenvectors obtained in (b) and calculate the standard deviation of residuals. d. Scale the excess returns of each asset by its associated residual standard deviation obtained in (c) and form a new scaled cross-product matrix of excess returns.

e. Repeat steps (b), (c) and (d) until convergence is achieved.5 3. The Multivariate Framework 3.1 Testing the APT for Mispricing

he tests in this paper are focused on a multivariate regression model that is an augmented version of Equation 3. Two basic variants are explored which relate to the existence of unconditional and conditional mispricing. First, a test for the absence of unconditional mispricing involves Equation 3 augmented by an intercept term (ai ) which captures general mispricing in the data, relative to the pricing model specified. The null hypothesis to be tested is the restriction that the

_ ____________ 3. Refer to Trzcinka (1986) and Faff (1988) for examples of the application of the standard principal components technique to empirical tests of the APT. 4. See Connor and Korajczyk (1986, pp.382384) for details. Also refer to Connor and Korajczyk (1988, pp.258259) for an intuitive discussion in a simple one factor case. 5. Connor and Korajczyk (1988) had very large subsample sizes (ranging from 1,487 to 1,745) and so, not surprisingly, found no benefit from using the iterated variant. Consequently, they did not indicate any specific criteria for determining convergence.

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intercept is zero across all (p) asset equations, that is, zero unconditional mispricing:6 H 0 : a 1 = a 2 = a 3 = . . . = ap = 0. (4)

The second variant incorporates monthly seasonal behaviour in stock returns as potential measures of conditional mispricing. It is desirable to include the monthly seasonal behaviour in Australia stock returns most relevant for our data period (1974 to 1987). The work of Brown, Keim, Kleidon and Marsh (1983) and Wood (1990a) suggests that seasonals for January, July and August need to be included in a risk-adjusted analysis.7 Hence, Equation 3 will be augmented by an intercept and three seasonal dummies, that is, Equation 3 plus: ai (NSEAS ) + ai (JAN ) DJAN + ai (JUL ) DJUL + ai (AUG ) DAUG , (5)

where: ai (NSEAS ) = the coefficient measuring non-seasonal-specific mispricing: ai (JAN ) = the coefficient measuring January-specific mispricing; ai (JUL ) = the coefficient measuring July-specific mispricing; ai (AUG ) = the coefficient measuring August-specific mispricing; DJAN = a dummy variable taking the value of unity in January, zero otherwise; DJUL = a dummy variable taking the value of unity in July, zero otherwise; and, DAUG = a dummy variable taking the value of unity in August, zero otherwise. In this situation two types of hypotheses can be testedone relates to the absence of non-seasonal-specific mispricing and the other relates to the absence of seasonal-specific mispricing. In the former case, the null hypothesis to be tested
_ ____________ 6. This assumes that the chosen risk free proxy is appropriate. If this is not so then rejection of H 0 may reflect that: (a) the APT is inappropriate; and/or, (b) the risk free rate is misspecified. 7. Brown et al. (1983) examined the period from March 1958 to June 1981 (of which the subperiod 1974 to 1981 is relevant to the current study). They found that risk-adjusted returns indicated seasonalities in January, July and August. Wood (1990a) examined the period 1974 to 1988. While this period fully encompasses our data period, the seasonality analysis focused on raw returns only and, hence, in our risk-adjusted framework, his results are suggestive only. He found a significant January and July seasonal across industrial firms and a significant July and August seasonal for small resource stocks. These results reinforce the January, July and August seasonals found by Brown et al. (1983) and justify their inclusion in our analysis. Wood also found a positive seasonal in April for small resource sector stocks, but since this was a raw return seasonal only and because it was not confirmed by Brown et al. (1983), the April seasonal was not included here.

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is: H 0 : a 1 (NSEAS ) = a 2 (NSEAS ) = a 3 (NSEAS ) = . . . = ap (NSEAS ) = 0. (6)

In the latter case, however, we can test for the absence of individual or joint seasonal mispricing. The null hypotheses for the case of zero individual mispricing are: H 0 : ai (JAN ) = 0; i = 1, . . . , p. H 0 : ai (JUL ) = 0; i = 1, . . . , p. H 0 : ai (AUG ) = 0; i = 1, . . . , p. The null hypothesis for the case of zero joint mispricing is: H 0 : ai (JAN ) = ai (JUL ) = ai (AUG ) = 0; i = 1 . . . , p. (8) (7a) (7b) (7c)

The standard procedure for testing these hypotheses in a multivariate setting requires the estimation of the appropriately specified system of restricted and unrestricted models for each case. Note that the restricted systems estimated in order to test Hypotheses 4 and 6 are Equation 3 and Equation 3 augmented by three seasonal dummy variables, respectively. Further, Equation 3 augmented by 5 is the common unrestricted system estimated in order to test Hypotheses 7a, 7b, 7c and 8. The multivariate regression framework requires that returns are multivariate normally distributed. In this paper the statistical tests are based on a modified likelihood ratio test (MLRT) statistic. The MLRT is given by:8
MLRT = T *

r) det ( _ _______ 1 , u) det (

(9)

where:

) = the determinant of the maximum likelihood estimate of the det ( r error covariance matrix from the restricted system; det ( u ) = the determinant of the maximum likelihood estimate of the covariance matrix from the unrestricted system; * T = (T k p ) p; and p = the number of equations in the multivariate regression system.

_ ____________ 8. See Connor and Korajczyk (1988, p.271).

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Given the assumption of normality, the MLRT has an exact small-sample F distribution with (p, T k p ) degrees of freedom. 3.2 Testing the APT Versus the Capital Asset Pricing Model (CAPM) In order to have a benchmark for comparison, an analogous range of tests as just ve comparison may described are also conducted for the standard CAPM. But a na be misleading as the APT and CAPM are non-nested models. Connor and Korajczyk (1988, p.288) suggested that procedures designed to compare nonnested models [similar to those used in Chen (1983)] will improve our understanding of the relative merits of the models. Following this suggestion, a multivariate extension of the C test used by Chen (1983) is performed in the current paper. Specifically, consider the artificial regression model

it, APT + (1 i ) r it, CAPM + error , rit = i r

where the independent variables are defined as:

(10)

it, APT = the excess return for cross-section i in the period t, predicted by r the (restricted) empirical specification of the APT in Equation 3; and, it, CAPM = the excess return for cross-section i in the period t, predicted by r an excess returns market model with implied CAPM restrictions imposed.
In the multivariate regression model framework, the null hypothesis which favours the APT over the CAPM is: H 0 : 1 = 2 = 3 = . . . = p = 1. Alternatively, the null hypothesis which favours the CAPM over the APT is: H 0 : 1 = 2 = 3 = . . . = p = 0. These hypotheses can be tested using the MLRT as previously defined. 4. Data 4.1 General Description (12) (11)

he data used in the current work are returns on Australian equity securities, calculated from the Price Relatives File of the Centre for Research in Finance (CRIF) at the Australian Graduate School of Management. The data set covers the 165 month period from January 1974 to September 1987 and is divided into three

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nonoverlapping 55 month subperiods for analysis.9 Securities are included in a subperiod sample if they have a complete price relative history in that period. This produces sample sizes of 303, 158 and 340 for the three subperiods, respectively. The market index employed is the value-weighted index, as supplied by CRIF, while the risk-free rate of return is estimated from a series of monthly observations on Thirteen Week Treasury Notes. To reduce the dimension of the equation system to feasible proportions, securities in each subperiod are allocated to ten10 equally weighted portfolios11 according to their beginning market capitalisation in each subperiod.12, 13 4.2 Use of Portfolios It is important to note that portfolios (rather than individual assets) are used for the reason of making the analysis statistically feasible. That is, the use of portfolios reduces the number of equations in the multivariate analysis to a number which can be estimated. [This is in contrast with the reason for using portfolios in traditional
_ ____________ 9. This fourteen-year period is chosen for analysis because January 1974 is the earliest month in which market capitalisation data is available. The empirical method involves individual firms being grouped into portfolios according to market capitalisation. The subperiod size was chosen so as to provide a balanced and independent coverage of the overall period, while maintaining acceptable sample sizes. 10. While the choice of ten portfolios is arbitrary, this number has been chosen in the vast majority of Australian based (and overseas) studies which have used market capitalisation as a portfolio formation variable. [For example, see Beedles, Dodd and Officer (1988).] 11. It is recognised that a potential computational bias occurs when using equally weighted portfolios based on a size ranking [see Blume and Stambaugh (1983)]. Wood (1990) analysed this bias based on size deciles of Australian companies. Using all companies in the AGSM database, he found the bias was most severe in the decile of the smallest firms, with relatively little bias for the other deciles. Given the data restrictions used here, very few of the companies in our sample will correspond to the companies included in Woods smallest decile. Hence, it is argued that, in the current context, the computational bias is minimal and can safely be ignored. 12. Given that the empirical set up involves size portfolios and regression models that include monthly seasonal dummy variables, it seems natural to use the current analysis to shed some light on how well the APT can explain size related anomalies. But it should be noted that such anomalies have invariably been found most pronounced in the very small firms, whereas the sample used here is clearly biased toward larger firms. This large firm bias is induced by the need to have complete price histories of all firms analysed. Unfortunately, with Australian data there is a relatively high incidence of missing data which tends to be more common amongst small firms. While this is less of a problem for U.S. data as used by Connor and Korajczyk (1988), it is interesting to note that even they lost 30% of the available firms for this reason (p.261, footnote 4). 13. The average beginning of subperiod size of companies in the smallest firm portfolio is $2.18 million compared to an average size of $450.64 million for the largest firm portfolio. This represents a two hundred fold difference. Notwithstanding the comments made in the previous footnote regarding the large firm sample bias, one would still expect to observe a relative firm size effect.

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(univariate) CAPM tests of the 1960s and 1970s. In these tests, portfolios were formed to attenuate the problem of errors-in-variables (EIV), introduced by the well known two-stage testing approach.] But the use of portfolios does come at a cost. The cost is that it will bias tests in favour of the null model to the extent that individual pricing errors offset each other in the selected portfolios. It is this concern which justifies selection of size-based portfolios, since there is ample prior evidence suggesting a strong and systematic CAPM pricing error for assets of similar size. Moreover, size-based portfolios have been found to provide a wide range of return and risk across portfolios. This is desirable for testing purposes because the variation of return and risk determines the degree of potential asset pricing information contained in the data. That is, in the extreme, if return and risk did not vary at all across portfolios, then the data would contain no information on how asset prices are formed. In this case, tests would be pointless. One could argue from the above that the tests should ideally be conducted on individual assets. While this is not impossible, it requires that a strong assumption be made regarding the covariance structure of returns. Indeed, Connor and Korajczyk (1988) conducted such tests (assuming that the covariance matrix on individual asset returns is block diagonal). But they concluded that their tests lacked power because of the large number of assets used relative to the small number of (monthly) observations used in the time-series dimension. It is for this reason that tests using individual assets were not conducted in the current paper. 5. Empirical Results 5.1 The Error of Approximation in the Factor Estimates: Simulation Evidence

s indicated earlier in Section 2.2, the asymptotic principal components approach involves using eigenvectors from the cross-product matrix of excess returns as proxies for the true factor matrix. But the validity of this application relies on the number of assets being large enough such that the error of approximation is immaterial. Connor and Korajczyk (1988) investigated the potential significance of this error by simulating true factors in their data and running regressions of the eigenvectors on the true factor matrix. On the basis of their simulation results, Connor and Korajczyk (1988, p.269) concluded that the asymptotic principal components technique provides accurate estimates of the pervasive economic factors. The number of assets available and used in the current paper is a far smaller number than that used by Connor and Korajczyk (1988). Consequently, the error of approximation in the factor estimates would seem to be a greater problem here. To assess the significance of the error, an identical simulation exercise is repeated using one subperiod of our data. The simulation is performed using the 55 month subperiod from August 1978 to February 1983, in which the sample size is 158. The true factors are taken to be the first five eigenvectors extracted from the original data for this - 242 -

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subperiod. Based on these true factors, a series of (simulated) returns is formed composed of a factor component and an idiosyncratic component. The correlational structure of returns is constructed to have an approximate factor structure, that is, non-zero idiosyncratic cross-sectional correlation ( ) is permitted. The crosssectional correlation values considered are: = 0.0, 0.1, 0.3, 0.5, 0.7, 0.8 and 0.9.14 The degree of error in the factor estimates is gauged by the R 2 value obtained from regressing the estimated factor on five true factors. A perfect R 2 value of unity indicates a factor estimate with zero error. These regressions were run across five iterations for each estimated factor. The average, maximum and minimum R 2 values across the different values for each of the first five estimated factors are reported in Table 1. The R 2 values are very large for low to intermediate values of ( = 0.0, 0.1, 0.3 and 0.5). For = 0.7 only the first three estimated factors show high R 2 values, whereas for = 0.8 and 0.9 only the first estimated factor reveals high R 2 values. These results are very similar to those found by Connor and Korajczyk (1988), at least in that the significance of the error becomes increasingly important as the assumed level of idiosyncratic correlation increases. Not surprisingly, however, due to the much smaller sample size used here, the importance of the error of approximation is more significant than in the U.S. study. Connor and Korajczyk (1988) found that the error appeared to be a problem only in the case of = 0.9 for the estimated factors four and five. But they argued that given the first five factors have been extracted, this high level of correlation is implausibly large. The results in Table 1 indicate that for our data the error of approximation is of concern at least for = 0.8 and perhaps also for = 0.7. It is argued here that even these values for are unrealistically high and that for more reasonable values of (< 0.7) the error of approximation in factor estimates is acceptable. This claim is likely to be even stronger in the other two subperiods since the sample size in both cases is double that available in the subperiod used in the simulation exercise. In any case, the results that are reported in the following sections should be read with due caution. 5.2 One-Step Versus Iterated Factor Estimates The first empirical issue to be resolved is whether it is necessary to go beyond the initial one-step factor estimates and perform an iterated analysis. It was found that considerable instability is observed between the initial and iterated estimates. While this indicates that the iterated optimal estimates may be desirable [in contrast to the results of Connor and Korajczyk (1988) with U.S. data], some criteria for determining convergence of these factor estimates must be specified.
_ ____________ 14. Refer to Connor and Korajczyk (1988, pp.267268) for a detailed description of the simulation framework employed.

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Table 1 A Simulation Comparison of the Asymptotic Principal Components Factor Estimates Versus True Factors For a Five Factor Model
_________________________________________________________________
Est. Factor Average R 2 Maximum R 2 Minimum R 2 _________________________________________________________________

1 0.981 0.985 0.972 2 0.968 0.988 0.953 3 0.951 0.976 0.898 4 0.895 0.910 0.850 5 0.871 0.882 0.835 0.1 1 0.978 0.982 0.969 2 0.955 0.972 0.928 3 0.930 0.956 0.869 4 0.899 0.918 0.891 5 0.860 0.881 0.852 0.3 1 0.972 0.973 0.972 2 0.963 0.980 0.922 3 0.900 0.960 0.800 4 0.900 0.921 0.889 5 0.846 0.911 0.829 0.5 1 0.959 0.967 0.931 2 0.958 0.964 0.937 3 0.809 0.827 0.801 4 0.751 0.781 0.722 5 0.652 0.822 0.344 0.7 1 0.876 0.919 0.839 2 0.847 0.887 0.785 3 0.544 0.569 0.494 4 0.323 0.745 0.162 5 0.293 0.739 0.147 0.8 1 0.757 0.824 0.687 2 0.141 0.436 0.031 3 0.197 0.245 0.153 4 0.271 0.314 0.205 5 0.371 0.438 0.342 0.9 1 0.479 0.531 0.444 2 0.103 0.283 0.038 3 0.092 0.122 0.054 4 0.179 0.221 0.090 5 0.096 0.189 0.049 _________________________________________________________________

0.0

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The overriding criterion used in this study is that a high correlation must be observed between factor estimates from consecutive iterations.15 Following this requirement, the necessary number of iterations for each subperiod were: ten for the 1974/78 subperiod, seven for the 1978/83 subperiod, and five for the 1983/87 subperiod.16 5.3 Seasonality in Factor Mean Returns As discussed earlier, a major advantage of the Connor and Korajczyk framework is that it allows for time variation in factor risk premiums. One specific case of such variation is monthly seasonality. This is of particular interest due to the prominence that monthly seasonality has achieved in the vast literature on capital market anomalies. The existence of monthly seasonals in factor risk premiums can potentially help explain the puzzle of observed seasonal patterns in share returns. Connor and Korajczyk (1988) tested for January seasonality in U.S. factor mean returns and found very strong evidence in favour of seasonality in the first four factors. Moreover, they attributed this seasonality as an important reason for the APTs ability, in subsequent tests, to explain away January seasonal mispricing. A similar test of seasonality in the mean factor returns is conducted in the ) on a constant current study by regressing each statistically estimated factor (F jt and three dummy variables representing the months of January, July and August, viz: =C +C D (13) F jt 0 1 JAN + C 2 DJUL + C 3 DAUG + error, where:

= the realised risk premium plus the factor F jt realisation for factor j in period t, statistically estimated using asymptotic principal components: C 0 , C 1 , C 2 , C 3 = unspecified regression coefficients; and, DJAN , DJUL , DAUG = dummy variables as defined for Equation 5, previously.

_ ____________ 15. In the first subperiod, for example, perfect positive correlation between the ninth and tenth iteration factor estimates was obtained for factors one through eight. More generally, correlations in all subperiods between the final two iterations were mostly around 0.98 and above. 16. It is important to recognise that while the iterative procedure offers potential gains in estimation efficiency, it may come at the cost of estimation risk. The Connor and Korajczyk (1988) analysis assumes that the true idiosyncratic variances are known, whereas in practice we use sample estimates. While these estimates are asymptotically valid, the fixed T facing the empirical researcher creates the estimation risk problem. [See Connor and Korajczyk (1988, p.260).] Consequently, this may place a limitation on the validity of the iterative estimates and so they should be treated with some caution.

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The results from estimating this regression are reported in Table 2 and indicate only very weak evidence of any monthly seasonality in the factor mean returns. In Table 2, for each subperiod, Panel A presents the results based on the initial , while Panel B presents the results based on the iterated estimates. estimates of F jt It can be seen that there is no consistent or strong seasonal pattern across subperiods either for the initial or for the iterated factor estimates. There is some evidence of a January seasonal in the first subperiod, with three (two) out of five iterated (initial) factors proving significant at the 5% level. But January does not appear important in either of the later subperiods. July seasonality is apparent in only one factor in each of the first and last subperiods using initial estimates and in only one factor in the last subperiod using iterated estimates. August seasonality is evident in at least one factor in every subperiod except the first (for the iterated estimates). The strength of this evidence of seasonality in mean factor risk premiums is disappointing. But the Connor and Korajczyk (1988) APT framework does allow for unspecified time variation in factor risk premium and the results of tests in this more general environment are still of great interest. It is to these we now turn our attention. 5.4 Tests of the APT: Unconditional Mispricing Presented in Table 3 are the modified likelihood ratio test (MLRT) statistics for the absence of unconditional mispricing (the null hypothesis in Equation 4) in a five factor APT model [APT (5)] and a ten factor APT model [APT (10)].17 For comparative purposes, the results for similar Sharpe-Lintner CAPM tests (using a value-weighted index return) are also provided in Table 3. It can be seen that for the CAPM and also for the initial APT (5) and APT (10) specifications, despite some minor subperiod support, in the overall period the aggregate test statistics indicate strong rejection of the null hypothesis of no unconditional mispricing. But in the case of both iterated APT models there is strong evidence that the null cannot be rejected in either the early subperiod or the later subperiod. This non-rejection is likewise evident in the overall period at the 10% level and in particular seems to favour the APT (5) model more.18
_ ____________ 17. The five [APT (5)] and ten [APT (10)] factor versions of the APT were conservatively chosen as the focus of analysis. While prior evidence supports three or four factors at most, it is not necessarily the case that factors will be economically important in the order that they are extracted by the principal components technique. For example, Faff (1988) found that the first, third and eighth factors (eigenvectors) seemed to be important. Moreover, their importance may vary over time in an unpredictable manner. Connor and Korajczyk (1988) also examined APT (5) and APT (10). 18. It is prudent to employ the 0.10 critical level for aggregate multivariate tests following the analysis of Gibbons and Shanken (1987, p.393).

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Table 2 Test Statistics and p-values for the Hypotheses That the Conditional Mean Factor Risk Premium in January, July and August, is Equal to the Unconditional Mean Factor Risk Premium
_ ________________________________________________________________________ Factor Time Period 1 2 3 4 5 _ ________________________________________________________________________ A. Initial Estimates 1974/11978/7 Jan1 2.382
(0.021)4

Jan 2.43
(0.019)

ns3

ns

ns

Jul 2.36
(0.022)

Aug 2.10
(0.040)

1978/81983/2 1983/31987/9

ns Jul 3.84
(0.000)

ns ns

ns Aug 3.08
(0.003)

Aug 1.74
(0.089)

ns ns

ns

B. Iterated Estimates 1974/11978/7 1978/81983/2 1983/31987/9 Jan 2.49

(0.016)

Jan 2.03
(0.048)

ns ns ns

Jan 2.45
(0.018)

ns ns Aug 2.60
(0.012)

ns ns

ns Jul 3.30
(0.002)

Aug 2.72
(0.009)

Aug 1.84
(0.071)

_ ________________________________________________________________________ Notes: 1. Month having significant difference from unconditional mean factor risk premium. 2. t-statistic from Equation 13 for month with significantly different (at a 10% level) mean factor risk premium. 3. No significant differences at the 10% critical level are found for the mean factor risk premiums. 4. The p-value is given in parentheses.

Connor and Korajczyk (1988, p.271) caution that comparing test results between the non-nested CAPM and APT models can be misleading . . . since a model that actually fits better (smaller values of | a |) may be rejected if the deviations are - 247 -

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Table 3 Modified Likelihood Ratio Test (MLRT) Statistics for the Absence of Unconditional Mispricing in the CAPM, APT (5) and APT (10)1
_______________________________________________________
APT (5) APT (10) CAPM Time Period Initial Iterated Initial Iterated _______________________________________________________

1974/11978/7 1978/81983/2 1983/31987/9

1.972
(0.061)
3

2.09
(0.049)

0.52
(0.866)

2.48
(0.023)

0.81
(0.621)

2.71
(0.011)

1.19
(0.326)

2.07
(0.051)

1.75
(0.108)

2.06
(0.056)

1.91
(0.069)

2.93
(0.008)

0.96
(0.492)

2.64
(0.016)

1.20
(0.324)

Overall period 3.074 2.62 0.32 3.10 1.00 (0.001) (0.004) (0.375) (0.001) (0.158) aggregate test _______________________________________________________ Notes: 1. Each subperiod uses ten portfolios sorted on market value. 2. Modified likelihood ratio test (MLRT) statistic [see Rao (1973, p.555)] which has an F distribution with (numerator, denominator) degrees of freedom of: (10, 44) for CAPM, (10, 40) for APT (5), and (10, 35) for APT (10). 3. The p-value is given in parentheses. 4. This value is the standard normal variate equivalent for the aggregated subperiod F-statistics.

measured more precisely (that is, the test has more power). They suggested that some evidence of this problem would be revealed by plotting the average estimates s) for each portfolio, across the different of the mispricing parameter (average a models. Given the similarity of our test results for the CAPM versus the initial (one-step) APT (5) and APT (10) models, comparative plots of these three should highlight the extent of the problem in this study.19 Hence, in Figure 1, a plot of the
_ ____________ 19. It should be noted that there is a bias in the mispricing estimates which is induced by errorsin-variables. It can be shown that this bias is a function of the covariance between the approximation errors and the factor sensitivities. [See Connor and Korajczyk (1988, p.270).] The bias may be a problem here due to the small samples involved. Hence, the plots presented in the Figures and the results reported later should be read with this in mind.

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average unconditional mispricing for the CAPM and for the one-step versions of APT (5) and APT (10) are given.

40 30 20 10 0 -10

Mispricing (% p.a.)

.. .. .. .. .. .. .. .. .. .. ....... ... ... ... .... .

.... ............ ..... ... .....

. .. .. . CAPM
APT (5) APT (10)

4 5 6 7 8 Size Portfolio Figure 1

9 10

Unconditional mispricing, 19741987 Generally, the plots reveal that CAPM has a higher average mispricing, particularly for the smallest company portfolio. But for all three models a discernible small firm effect is evident, although it is clearly strongest for the CAPM. This would suggest that the APT is being rejected with smaller pricing errors because they are being estimated more precisely. 5.5 Tests of the APT: Conditional Mispricing As suggested in Section 3.1, we can also test for the absence of conditional mispricing in terms of the January, July and August seasonal behaviour observed in Australian data. The results of these tests for the individual seasonal effects, involving hypotheses (7a), (7b) and (7c), are reported in Table 4. It is apparent from Table 4 that none of the models have much difficulty explaining individually January, July or August related conditional mispricing. The subperiod and overall period test statistics are very small indeed, relative to conventionally applied critical values. But this analysis can be extended in two important ways. First, in a similar fashion to the results of Table 3, it may be instructive to examine the relative plots of average seasonal-specific mispricing for evidence of differential testing power across models. The second approach is to conduct a test of the (stronger) joint hypothesis of zero January, July and August conditional - 249 -

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Table 4
MLRT Statistics for the Absence of Conditional Mispricing (Individual

January, July and August Seasonality) in the CAPM, APT (5) and APT (10)1
______________________________________________________________________
CAPM APT (5) APT (10) Null Time Period Initial Iterated Initial Iterated Hypothesis2 ______________________________________________________________________

1974/11978/7

ai (JAN ) = 0 ai (JUL ) = 0 ai (AUG ) = 0

1.663
(0.124)4

1.41
(0.216)

1.86
(0.084)

1.21
(0.324)

1.94
(0.076)

1.04
(0.426)

0.70
(0.715)

1.42
(0.208)

0.78
(0.650)

2.14
(0.050)

1.32
(0.251)

1.61
(0.142)

1.62
(0.140)

1.20
(0.329)

1.97
(0.071)

1978/81983/2

ai (JAN ) = 0 ai (JUL ) = 0 ai (AUG ) = 0

0.94
(0.507)

0.70
(0.715)

0.77
(0.658)

0.74
(0.682)

1.07
(0.413)

0.35
(0.959)

0.17
(0.998)

0.19
(0.996)

0.39
(0.940)

0.66
(0.753)

0.47
(0.902)

0.46
(0.903)

0.51
(0.873)

0.77
(0.658)

0.44
(0.916)

1983/31987/9

ai (JAN ) = 0 ai (JUL ) = 0 ai (AUG ) = 0

0.93
(0.515)

1.16
(0.350)

1.07
(0.407)

1.48
(0.192)

1.25
(0.297)

1.25
(0.291)

0.65
(0.764)

0.72
(0.699)

0.49
(0.881)

0.88
(0.563)

1.03
(0.440)

1.03
(0.441)

0.89
(0.553)

1.07
(0.413)

1.02
(0.446)

Overall period aggregate test

ai (JAN ) = 0 ai (JUL ) = 0 ai (AUG ) = 0

0.635
(0.263)

0.35
(0.364)

0.70
(0.243)

0.49
(0.310)

1.26
(0.104)

0.58
(0.719)

2.38
(0.991)

1.34
(0.910)

1.80
(0.964)

0.46
(0.322)

0.27
(0.607)

0.05
(0.519)

0.11
(0.544)

0.15
(0.441)

0.13
(0.447)

______________________________________________________________________ Notes: 1. Each subperiod uses ten portfolios sorted on market value. 2. i = 1, 2, . . . , 10. 3. Modified likelihood ratio test (MLRT) statistic [see Rao (1973, p.555)] which has an F distribution with (numerator, denominator) degrees of freedom of: (10, 41) for CAPM, (10, 37) for APT (5), and (10, 32) for APT (10). 4. The p-value is given in parentheses. 5. This value is the standard normal variate equivalent for the aggregated subperiod F-statistics.

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mispricing. These two aspects are now considered in turn. In Figures 2 to 5, average mispricing relating to the conditional seasonal model specifications are plotted for the CAPM versus the initial five and ten factor specifications. Figure 2 shows the average non-seasonal-specific mispricing for the three models. This is similar to Figure 1, showing relatively larger mispricing evident for the CAPM, particularly for the smallest firm portfolio. Figure 3 reveals average January-specific conditional mispricing. In contrast to the results of Connor and Korajczyk (1988), the APT does not provide an adequate explanation of this seasonality. Significant mispricing is observed particularly in the mid-sized portfolios (20% to 30% per annum) for both the CAPM and APT models. In Figure 4, average conditional mispricing that is specific to July is plotted for the ten size portfolios. Here, very large average mispricing of around 90% and 60% per annum is observed for the CAPM for the smallest two firm size portfolios, respectively. This mispricing is much larger than the maximum mispricing (10% to 20% per annum) found for the APT models. While a small firm effect is still evident for the APT, it is clearly much less pronounced than for the CAPM. Finally, in Figure 5 the average August-specific-conditional mispricing is displayed. A small firm effect is evident for all models, but again it is less prominent for the APT. In general all these seasonal specific plots reinforce the suggestion that the APT tests have stronger power because of the more precise estimation of mispricing coefficients. As discussed earlier, a further extension of the seasonality mispricing issue is achieved by testing the hypothesis (given by Equation 8 previously) of joint zero mispricing in January, July and August. The results of this analysis are found in Table 5. In stark contrast to the results of Table 4, in virtually all subperiods, and indeed in the overall period, test statistics for all models provided a resounding rejection of the null hypothesis. That is, the data will not support the conclusion that January, July and August mispricing is jointly zero, whereas we could reject their individual mispricing effects.20 Also contained in Table 5 are the results of testing the null hypothesis of zero non-seasonal-specific mispricing (given by Equation 6). It finds support only in the iterated version of APT (5). 5.6 Tests of the APT versus the CAPM Finally, in Table 6 results for the non-nested tests described in Section 3.2 are provided. In Panel A, the univariate results for each individual portfolio are
_ ____________ 20. The very strong rejection of the CAPM and APT models due to the existence of (joint) January, July and August mispricing provides solid support for the initial choice of this monthly seasonal structure in returns. This set of seasonals has provided sufficient power for the tests to reject the null models.

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30 25 20 Mispricing 15 (% p.a.) 10 5 0 -5 1 2 3 4 5 6 7 8 Size Portfolio Figure 2 Conditional mispricing: non-seasonal-specific, 19741987 9 10 .. .. .. .. .. .. .. . .. .. ........ .. .. .. .. .. .. . .. .. .. ....... ... . .. . . .. ... .... .. . . ... . .. ... ..... .. .. ... ... ..... .

.. ..... CAPM
APT (5) APT (10)

40 30 20 Mispricing 10 (% p.a.) 0 -10 -20 1 2 3 4 5 6 7 8 Size Portfolio Figure 3 Conditional mispricing: January-specific, 19741987 9 10 .... . . . . ..... . .. . . .. . . ... . . . ..... . . . . . . . . . . . .. .. ... .. .... . . . . . . ... . . . .. . .. ... ... . . . ... . . .. . .. .. . ... .. . . . . . .. . ... .. . . . . .. . .. .. .. APT (10) . .. . .. .. . CAPM .. . ... .. .. APT (5) ... .

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100 80 60 Mispricing 40 (% p.a.) 20 0 -20

.. .. .. .. .. .. .. .. .. .. .. .. ...... . .. . . ... .. . . .. .. .... .. . . .. .. . ... .. ..... ..... ... ..... ... ..... ......... . CAPM .....

APT (10) APT (5)

4 5 6 7 8 Size Portfolio Figure 4

9 10

Conditional mispricing: July-specific, 19741987

40 30 20 Mispricing 10 (% p.a.) 0 -10 -20

.. ..... .... .. .. .. .. .. .. .. .... .. ..

.... .. .. . CAPM .. .. ... . . . . .. . .. ... ......... .. .. . .. ...

APT (5) APT (10)

4 5 6 7 8 Size Portfolio Figure 5

9 10

Conditional mispricing: August-specific, 19741987

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Table 5
MLRT Statistics for the Absence of Conditional Mispricing (joint

January, July and August Seasonality) in the CAPM, APT (5) and APT (10)1
_ ________________________________________________________________________
CAPM APT (5) APT (10) Null Time Period Initial Iterated Initial Iterated Hypothesis2 _ ________________________________________________________________________

1974/11978/7

ai (NSEAS ) = 0 ai (JAN ) = ai (JUL ) = ai (AUG ) = 0

1.573
(0.152)4

1.66
(0.129)

0.79
(0.642)

1.97
(0.071)

1.34
(0.250)

5.18
(0.000)

5.24
(0.000)

7.27
(0.000)

4.52
(0.000)

11.07
(0.000)

1978/81983/2

ai (NSEAS ) = 0 ai (JAN ) = ai (JUL ) = ai (AUG ) = 0

2.28
(0.031)

1.33
(0.250)

1.98
(0.065)

1.69
(0.126)

1.66
(0.133)

1.79
(0.094)

1.49
(0.182)

1.56
(0.157)

2.21
(0.043)

2.28
(0.038)

1983/31987/9

ai (NSEAS ) = 0 ai (JAN ) = ai (JUL ) = ai (AUG ) = 0

1.67
(0.122)

2.79
(0.011)

1.24
(0.299)

2.42
(0.028)

1.44
(0.206)

3.76
(0.001)

3.22
(0.005)

3.12
(0.006)

3.79
(0.002)

3.64
(0.003)

Overall period aggregate test

ai (NSEAS ) = 0

2.345
(0.010)

2.36
(0.009)

0.97
(0.166)

2.61
(0.004)

1.50
(0.066)

ai (JAN ) = ai (JUL ) 4.71 4.19 4.65 4.55 5.53 (0.000) (0.000) (0.000) (0.000) (0.000) = ai (AUG ) = 0 _ ________________________________________________________________________ Notes: 1. 2. 3. Each subperiod uses ten portfolios sorted on market value. i = 1, 2, . . . , 10. Modified likelihood ratio test (MLRT) statistic [see Rao (1973, p.555)] which has an F distribution with (numerator, denominator) degrees of freedom of: (10, 41) for CAPM, (10, 37) for APT (5), and (10, 32) for APT (10). The p-value is given in parentheses. This value is the standard normal variate equivalent for the aggregated subperiod F-statistics.

4. 5.

reported, based on the estimation of a regression given by Equation 10. Generally, the results indicate support for the APT in all but the largest size portfolios. For example, consider the third subperiod. The analysis involving Portfolio 1 (smallest companies) through to Portfolio 5 gives support to the one-step APT (5) model (H 0 : = 1) and rejects the CAPM (H 0 : = 0). In the case of Portfolio 6 through to Portfolio 9, neither model is supported. It is only in the case of Portfolio 10

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Table 6 A Non-nested Comparison of APT (5) Versus CAPM1

_ _____________________________________________________________ 1974/11978/7 1978/81983/2 1983/31987/9 Initial Iterated Initial Iterated Initial Iterated _ _____________________________________________________________

A. Univariate Analysis

1
(smallest)

0.9901
(0.042)2

0.9963
(0.069)

1.1376
(0.087)

0.9592
(0.122)

1.0133
(0.076)

1.0540
(0.093)

2 3 4 5 6 7 8 9 10
(largest) H0 : i = 1

1.0557
(0.085)

0.9835
(0.088)

1.0914
(0.104)

1.1668
(0.256)

1.0587
(0.060)

1.1596
(0.138)

1.0978
(0.106)

1.0381
(0.107)

0.9684
(0.143)

1.0068
(0.171)

0.9386
(0.087)

1.0025
(0.133)

1.0370
(0.107)

1.0571
(0.091)

1.0577
(0.216)

1.2060
(0.216)

1.0675
(0.116)

1.1235
(0.229)

1.0220
(0.094)

1.0072
(0.073)

1.0313
(0.129)

1.0547
(0.127)

0.9965
(0.068)

1.0410
(0.094)

0.9823
(0.085)

0.9840
(0.067)

0.9671
(0.166)

1.2173
(0.206)

0.6921
(0.095)

1.0298
(0.116)

0.8976
(0.093)

0.8893
(0.110)

0.9641
(0.057)

0.9997
(0.050)

0.6587
(0.112)

1.1247
(0.164)

0.9124
(0.067)

0.9096
(0.080)

0.8073
(0.136)

1.0874
(0.125)

0.3737
(0.112)

0.8940
(0.159)

0.7491
(0.061)

0.8157
(0.068)

0.6547
(0.141)

1.0078
(0.142)

0.2385
(0.077)

0.8649
(0.086)

0.3129
(0.067)

0.5549
(0.065)

0.1432
(0.103)

0.5818
(0.108)

0.0815
(0.066)

0.5380
(0.093)

B. Multivariate Analysis 3.623

(0.001)
4

2.93
(0.007)

4.03
(0.001)

0.94
(0.507)

11.75
(0.000)

2.08
(0.047)

i = 1, 2, . . . , 10 [that is, APT (5)] _ _____________________________________________________________ Notes: 1. The non-nested comparison is based on the C-test framework of Davidson and MacKinnon (1981). 2. Standard Errors in parentheses. 3. Modified likelihood ratio test (MLRT) statistic [see Rao (1973, p.555)] which has an F distribution with (10, 44) degrees of freedom. 4. The p-values are in parentheses.

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(largest companies) that the CAPM is supported and the APT rejected.21 For the iterated APT (5) model, Portfolio 1 through to Portfolio 9 support the APT and reject the CAPM, while Portfolio 10 supports neither model. These results tend to confirm earlier analysis suggesting that the APT models are superior at pricing all but the larger firms, whereas CAPM (at best) only has some ability in pricing the largest firms. In Panel B of Table 6, the associated multivariate statistics for the nonnested tests of APT (5) across the ten portfolios are presented. The APT (5) model can only be clearly accepted for the middle subperiod and is marginal in the third subperiod (in both cases for the iterated five factor model). In unreported results it is (not surprisingly) found that similar multivariate tests of the converse situation, that is, CAPM as the null hypothesis (that is, H 0 : 1 = 2 = 3 = . . . = 10 = 0 ), show absolutely no support for the null in any subperiod or indeed overall. 6. Conclusions and Summary he asymptotic principal components technique, developed by Connor and Korajczyk (1988), was used to provide factor estimates necessary for the testing of an equilibrium version of the arbitrage pricing theory (APT) with time varying risk premia. Both one-step and iterative versions of the method were used. The tests were based on cross-equation restrictions imposed by the APT on a multivariate regression of excess returns on the estimated factors. This work extends and improves the previous research by Faff (1988) in three major ways. First, the empirical technique has allowed examination of smaller subperiods which involves a more realistic assumption regarding stationarity. Second, by using the multivariate approach, rather than the traditional two-stage method, the errors-in-variables problem is considerably reduced. Finally, following the work of Brown, Keim, Kleidon and Marsh (1983) and Wood (1990a), the analysis incorporates dummy variables for monthly seasonality effects. In this paper, tests are performed using Australian monthly equity return data in the period 1974 to 1987. In general, the results provided only weak support for the APT model. Unconditional mispricing cannot be rejected for the initial onestep versions of a five factor and a ten factor APT nor for the CAPM. In contrast, the iterated versions of the APT models do not reveal significant unconditional mispricing. Conditional mispricing was tested by augmenting the multivariate regression model with January, July and August seasonal dummy variables. The absence of individual seasonal mispricing (that is, January or July or August) cannot be rejected for any model. But joint seasonal mispricing (that is, January
_ ____________ 21. Note that there are four possible sets of conclusions. We can: (a) reject the APT and accept the CAPM; (b) accept the APT and reject the CAPM; (c) reject both models; or (d) accept both models.

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and July and August) is significant for all models. Finally, multivariate non-nested tests of the restrictions imposed by CAPM versus APT favour an (iterated) five factor APT. While the APT appears to perform better than the CAPM, neither model can adequately explain seasonal mispricing in Australian equities.
(Date of receipt of final typescript: December 1992.)

References Ball, R., P. Brown and R. Officer, 1976, Asset pricing in the Australian industrial equity market, Australian Journal of Management, 1, 1, 132. Beggs, J.J., 1986, A simple exposition of the arbitrage pricing theory approximation, Australian Journal of Management, 11, 1, 1322. Blume, M. and R. Stambaugh, 1983, Biases on computed returns: an application to the size effect, Journal of Financial Economics, 12, 3, 387404. Brown, P., D. Keim, A. Kleidon and T. Marsh, 1983, Stock return seasonalities and the tax-loss selling hypothesis: analysis of the arguments and Australian evidence, Journal of Financial Economics, 12, 1, 105127. Chamberlain, G. and M. Rothschild, 1983, Arbitrage, factor structure and mean-variance analysis on large asset markets, Econometrica, 51, 5, 12811304. Chen, N-F, 1983, Some empirical tests of the theory of arbitrage pricing, The Journal of Finance, 38, 5, 13931414. Connor, G. and R. Korajczyk, 1986, Performance measurement with the arbitrage pricing theory: a new framework for analysis, Journal of Financial Economics, 15, 3, 373394. Connor, G. and R. Korajczyk, 1988, Risk and return in an equilibrium APT: application of a new test methodology, Journal of Financial Economics, 21, 2, 255289. Davidson, R. and J. MacKinnon, 1981, Several tests of model specification in the presence of alternative hypotheses, Econometrica, 49, 3, 781793. Faff, R., 1988, An empirical test of the arbitrage pricing theory on Australian stock returns 197485, Accounting and Finance, 28, 2, 2343. Faff, R., 1990, An empirical test of arbitrage equilibrium with skewed asset returns: Australian evidence, Working Paper No. 32, Department of Accounting and Finance, Monash University, Clayton. Faff, R., 1991, A likelihood ratio test of the zero-beta CAPM in Australian equity returns, Accounting and Finance, 31, 2, 8895. Fama, E. and J. MacBeth, 1973, Risk, return and equilibrium: empirical tests, Journal of Political Economy, 81, 3, 607636. Gibbons, M. 1982, Multivariate tests of financial models: a new approach, Journal of Financial Economics, 10, 1, 327. Gibbons, M. and J. Shanken, 1987, Subperiod aggregation and the power of multivariate tests of portfolio efficiency, Journal of Financial Economics, 19, 2, 389394.

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Vol.17, No.2

Faff: ARBITRAGE PRICING THEORY

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