Factor Models

Th e following technical assumptions must be satisfi ed to make use of estimation by the Ordinary Least Squares (OLS) method and statistical inference in factor models:

Th e expected value of the error term• must be zero, E(εi) = 0, i = 1, 2, …, n. Factors and error terms should be• uncorrelated, Cov(Fj, εi) = 0, j = 1, 2, …, k. Error terms should not be autocorre-• lated, Cov(εi, εj) = 0, i ≠ j. All error terms must have the same• variance, E(εi2) = σ2.