Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 524: Choosing Factors in a Multifactor Asset Pricing Model: A Bayesian Approach

Johan Ericsson () and Sune Karlsson ()
Additional contact information
Johan Ericsson: Dept. of Economic Statistics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Sune Karlsson: Dept. of Economic Statistics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: We use Bayesian techniques to select factors in a general multifactor asset pricing model. From a given set of 15 factors we evaluate all possible pricing models by the extent to which they describe the data as given by the posterior model probabilities. Interest rates, premiums, returns on broadbased portfolios and macroeconomic variables are included in the set of considered factors. Using different portfolios as the investment universe we find strong evidence that a general multifactor pricing model should include market excess return, size premium, value premium and the momentum factor. There is some evidence that yearly growth rate in industrial production and term spread also are important factors.

Keywords: asset pricing; factor models; Bayesian model selection

JEL-codes: C11; C52; G12

19 pages, First version: April 3, 2003. Revised: February 12, 2004.

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