Underspecification of the Empirical Return-Factor Model and a Factor Analytic Augmentation as a Solution to Factor Omission

The only certainty is uncertainty: An analysis of the impact of COVID-19 uncertainty on regional stock markets

“…Additionally, a factor analytically derived factor set, , is incorporated into equation (1) to account for influences that may not be reflected by R ε IM,t . Factors comprising the factor analytic augmentation, accounting for both contemporaneous and lagged relationships, are derived from regional return series and are then adjusted for the impact of Δ CV 19 I t and R ε IM,t ( Szczygielski et al, 2020 ). 6 For parsimony, only significant proxy factors are retained.…”

“… 6 Szczygielski et al (2020) show that a residual market factor may be insufficient to ensure residual correlation matrix diagonality, implying that a model omits factors with a systematic (common) impact. The inclusion of a factor analytic augmentation is shown to result in a diagonal residual matrix.…”

Impact of COVID-19 pandemic disease outbreak on the global equity markets

“…Equations 1and 2are exclusively designed to address equity returns based on a single factor affecting amid COVID-19. However, Chipeta and Szczygielski (2015) and Szczygielski et al (2020) present excellent empirical evidence on the underspecification and residual market factor with factor omission and likely consequences on the return behaviour. Szczygielski et al (2020) consider monthly returns from the Johannesburg Stock Exchange (JSE) addressing several industries in a time series framework with a multifactor model.…”

“…However, Chipeta and Szczygielski (2015) and Szczygielski et al (2020) present excellent empirical evidence on the underspecification and residual market factor with factor omission and likely consequences on the return behaviour. Szczygielski et al (2020) consider monthly returns from the Johannesburg Stock Exchange (JSE) addressing several industries in a time series framework with a multifactor model. Our single factor return model is based on the equity index of daily data obtained from 12 countries in the panel data framework; it is not possible to add multiple macroeconomic factors across the countries with different frequencies.…”