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By using the Fama and MacBeth methodology, I have identified the significant factors that explain the returns of my stocks. Now, I want to build a portfolio and backtest it.

For that, I am trying to use the Mean(factor loadings) and the respective betas. However, to calculate the expected return, should I take only the SIGNIFICANT factors or ALL THE FACTORS? P.S. : I only have one significant factor.

Thanks in advance, Vaibhav

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Statistically speaking you should not include the factor that aren't significant. Economically speaking you should take all the factors because intuitively they explain the returns of the assets, and if you don't do it will incur in specification bias by omit the factors and will cause the the estimates aren't efficient, unbiased and consistent

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  • $\begingroup$ Thanks a lot for the reply. For the analysis, I included all the factors ! and explained why they should be in my model.. and why they might not be significant ! ! $\endgroup$
    – Vaibhav
    Dec 12, 2015 at 22:12

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