Shrinking factor dimension: A reduced-rank approach

• Main Authors: HE, Ai, HUANG, Dashan, LI, Jiaen, ZHOU, Guofu
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2023
• Subjects: reduced rank; PCA; PLS; factors; factor model; cross section; Corporate Finance; Finance and Financial Management
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/5924; https://ink.library.smu.edu.sg/context/lkcsb_research/article/6923/viewcontent/SSRN_id3205697.pdf
• Institution: Singapore Management University

We propose a reduced-rank approach (RRA) to reduce a large number of factors to a few parsimonious ones. In contrast to PCA and PLS, the RRA factors are designed to explain the cross section of stock returns, not to maximize factor variations or factor covariances with returns. Out of 70 factor prox...