The Number of Factors in Security Returns

Abstract

Both factor analysis of security returns and the analysis of eigenvalues seem to indicate that a market factor explains the major part of security returns. We find that such evidence is consistent with an economy where there are in factk“equally important” priced factors; eigenvalue analysis in the context of such an economy will lead an investigator to the false inference that the one important “factor” is the return on anequally weightedmarket index.