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1. 1. Principal Component Analysis and the Cross-Sectional Variation of Returns

   University essay from

   Author : Armin Ramovic; Mikael Åkerman; [2021-06-23]
   Keywords : Principal Component Analysis; PCA; principal components; cross-sectional variation of returns; risk premia; asset pricing; demensionality reduction; risk factors; machine learning;

   Abstract : We utilize Principal Component Analysis (PCA), a dimensionality reduction technique, on a set of 142 risk factors, including macroeconomic factors, proposed in financial literature to construct factor models with high explanatory powers when analysing the cross-sectional variation of portfolio returns. We apply a Fama and Macbeth (1973) two-pass regression to estimate risk premia commanded by our principal components. READ MORE