A multifactor model of stock returns with endogenous regime switching

Abstract

We estimate a state-dependent multifactor model with two endogenous states. Its pricing accuracy is slightly superior to that of the Fama and French (1993, 1996) model. We have evidence for dramatically increased factor loadings for distress factors in one state. These results have implications for cost-of-capital calculations, portfolio management, risk analysis and other applications.Empirical asset pricing, endogenous regime switching, state-dependent models, nonstandard maximum-likelihood estimation