We propose a new method for estimating latent asset pricing factors that fit the time-series and cross-section of expected returns. Our estimator generalizes Principal Component Analysis (PCA) by including a penalty on the pricing error in expected returns. We show that our estimator strongly...

We develop an estimator for latent factors in a large-dimensional panel of financial data that can explain expected excess returns. Statistical factor analysis based on Principal Component Analysis (PCA) has problems identifying factors with a small variance that are important for asset pricing....