A general randomized test for Alpha

We propose a methodology to test for the null hypothesis that the alphas of a panel of asset returns are jointly equal to zero in a linear factor pricing model with observable and tradable factors — that is, the null of “zero alpha”. The test is based on equation-by-equation estimation, using a randomized version of the estimated alphas, which only requires rates of convergence. The distinct features of the proposed methodology are that it does not require the estimation of any covariance matrix, and that it allows for both N and T to pass to infinity, with the former possibly faster than the latter. Further, unlike extant approaches, the procedure can accommodate conditional heteroskedasticity, non-Gaussianity, and strong cross-sectional dependence in the error terms. We also propose a derandomized decision rule to choose in favor or against the correct specification of a linear factor pricing model. Monte Carlo simulations show that the test has satisfactory properties and it compares favorably to several existing tests. The usefulness of the testing procedure is illustrated through an application of linear factor pricing models to the constituents of the S&P 500.

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Publication Details

Journal
Journal of the American Statistical Association
Published
2026-09-28
DOI
https://doi.org/10.1080/01621459.2026.2735067
Primary Topic
Spatial and Panel Data Analysis
Type
article
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article

A general randomized test for Alpha

Lorenzo Trapani, Lucio Sarno, Pierluigi Vallarino, Daniele Massacci
Journal of the American Statistical Association
Spatial and Panel Data Analysis
article

A general randomized test for Alpha

Lorenzo Trapani, Lucio Sarno, Pierluigi Vallarino, Daniele Massacci
article en

Abstract

We propose a methodology to test for the null hypothesis that the alphas of a panel of asset returns are jointly equal to zero in a linear factor pricing model with observable and tradable factors — that is, the null of “zero alpha”. The test is based on equation-by-equation estimation, using a randomized version of the estimated alphas, which only requires rates of convergence. The distinct features of the proposed methodology are that it does not require the estimation of any covariance matrix, and that it allows for both N and T to pass to infinity, with the former possibly faster than the latter. Further, unlike extant approaches, the procedure can accommodate conditional heteroskedasticity, non-Gaussianity, and strong cross-sectional dependence in the error terms. We also propose a derandomized decision rule to choose in favor or against the correct specification of a linear factor pricing model. Monte Carlo simulations show that the test has satisfactory properties and it compares favorably to several existing tests. The usefulness of the testing procedure is illustrated through an application of linear factor pricing models to the constituents of the S&P 500.

Journal of the American Statistical Association
University of Leicester (GB), King's College London (GB), University of Cambridge (GB), University of Pavia (IT), Centre for Economic Policy Research (GB), Università della Svizzera italiana (CH)
Peace, Justice and strong institutions
Openalex Percentile: Top 5%
Spatial and Panel Data Analysis
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A general randomized test for Alpha — Lorenzo Trapani, Lucio Sarno, et al. · Journal of the American Statistical Association (2026) | TGRS Research Map | TGRS