Testing conditional factor models

We develop a methodology for estimating time-varying alphas and factor loadings based on nonparametric techniques. We test whether conditional alphas and long-run alphas, which are averages of conditional alphas, are equal to zero and derive test statistics for the constancy of factor loadings. The tests can be performed for a single asset or jointly across portfolios. The traditional Gibbons, Ross, and Shanken (1989) test arises as a special case of no time variation in the alphas and factor loadings and homoskedasticity. As applications of the methodology, we estimate conditional CAPM and multifactor models on book-to-market and momentum decileportfolios. We reject the null that long-run alphas are equal to zero even though there is substantial variation in the conditional factor loadings of these portfolios.