Nonsynchronous Data and the Covariance-Factor Structure of Returns



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    • Assistant Professor of Finance at the University of Rochester. This paper was presented at the Conference on Empirical Work on Arbitrage Pricing at U.S.C. and the Workshop on Arbitrage Pricing at the 1986 NBER Summer Institute. I am grateful to the participants and to G. Connor, G. Rubio, B. Schwert, M. Weinstein, and anonymous referees for helpful suggestions. Computational assistance was provided by A. Tajirian.


Evidence is presented that indicates that the standard estimator of the covariance matrix of daily returns provides a distorted view of the true covariance-factor structure. An alternative estimator, based on a model of the price-adjustment delay process, reveals roughly twice as much covariation in individual security returns. The number of factors identified also appears to increase when this estimator is employed. Since the linear space spanned by the estimated factor-loading vectors is quite sensitive to the estimator used, it is important that the consistent estimator be considered in the usual two-stage empirical investigations of the APT.