High dimensional alpha test for linear factor pricing model with $L_q$-norm

Abstract

We consider testing zero pricing errors in high-dimensional linear factor pricing models. Existing methods are mainly based on either an $L_2$ statistic, which is effective under dense alternatives, or an $L_\infty$ statistic, which is powerful under very sparse alternatives. To bridge these two regimes, we develop a class of $L_q$-based tests for finite $q$, including the practically useful $L_4$ and $L_6$ cases. We show that larger $q$ leads to greater sensitivity to sparse alternatives. We further establish the asymptotic independence between the $L_\infty$ statistic and the $L_q$ statistic for any finite $q$, which motivates a Cauchy combination test that adapts to a broad range of sparsity levels. Simulation studies and a real-data analysis show that the proposed methods are more robust to the unknown sparsity of the alternative and can outperform existing procedures in finite samples.