Applications of Reduced-Rank Regression in Financial Economics
In previous chapters, we have developed reduced-rank regression models of various forms, which have wide applications in a variety of contexts in the physical and social sciences. In this chapter we focus on the area of financial economics, where several applications of the reduced-rank regression models arise in a fairly natural way. Thus, the topics that will be examined in this chapter involve consideration of the contexts in which financial models arise from economic theories, the form of the models, and the empirical verification of these models through reduced-rank regression methods. In earlier chapters, the application of reduced-rank regression methods was mainly motivated from an empirical dimension-reduction aspect, whereas the use of reduced-rank models presented in this chapter results from a priori economic theory. With the high volume of financial data that are now routinely becoming available, these theories can be examined through tests of the models. We point out that, for the most part, only the basic reduced-rank methods developed in Chapter 2 are needed for the presentations considered here.
KeywordsStock Return Financial Economic Excess Return Capital Asset Price Model Asset Price Model
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