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Home | Events | Optimal Maximin GMM Tests for Sphericity in Latent Factor Analysis of Short Panels
Seminar

Optimal Maximin GMM Tests for Sphericity in Latent Factor Analysis of Short Panels


  • Location
    Erasmus University Rotterdam, Campus Woudestein, ET-14
    Rotterdam
  • Date and time

    October 22, 2025
    12:00 - 13:00

Abstract

We derive optimal maximin tests for parametric hypotheses in short panels with latent common factors. We rely on a Generalized Method of Moments setting with optimal weighting under a large cross-sectional dimension n and a fixed time series dimension T. We outline the asymptotic distributions of the estimators as well as the asymptotic maximin optimality of the Wald, Lagrange Multiplier, and Likelihood Ratio-type tests. The characterisation of optimality relies on finding the limit Gaussian experiment in strongly identified GMM models under a block-dependence structure and unobserved heterogeneity. We reject sphericity of idiosyncratic errors in an empirical application to a large cross-section of U.S. stocks, which casts doubt on the validity of routinely applying Principal Component Analysis to short panels of monthly financial returns.

Joint paper with Alain-Philippe Fortin, Patrick Gagliardini, Olivier Scaillet.