Connor, Gregory and Linton, Oliver (2006) Semiparametric estimation of a characteristic-based factor model of common stock returns. EM/2006/506. Suntory and Toyota International Centres for Economics and Related Disciplines, London School of Economics and Political Science, London, UK.
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We introduce an alternative version of the Fama-French three-factor model of stock returns together with a new estimation methodology. We assume that the factor betas in the model are smooth nonlinear functions of observed security characteristics. We develop an estimation procedure that combines nonparametric kernel methods for constructing mimicking portfolios with parametric nonlinear regression to estimate factor returns and factor betas simultaneously. The methodology is applied to US common stocks and the empirical findings compared to those of Fama and French.
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