Arbitrage and the evaluation of linear factor models in U.K. stock returns: the official publication of the Eastern Finance Association

I examine the impact of the no arbitrage restriction on the estimation and evaluation of linear fac-tor models in U.K. stock returns. The no arbitrage restriction reduces volatility and eliminates most of the negative values of the fitted stochastic discount factor models. All of the factor mod-els are rejected and there are significant differences in the pricing performance between models under the no arbitrage restriction. The no arbitrage restriction can have a significant impact on both the parameter estimates and pricing errors for some models