equities - What are the econometric assumptions in the Fama-Macbeth procedure (1973)?

Fama-Macbeth (1973) introduce a two stage cross-sectional regression method (http://en.wikipedia.org/wiki/Fama%E2%80%93MacBeth_regression).

1) If I was to regress stock prices (or returns) on a condtioning set using the Fama-Macbeth regression method, what are the econometric assumptions behind this model?

2) Is the model still used today or is another model now prefered?

Answer

2) Alternative to Fama-MacBeth is Fama-French approach. Explanation of difference see, for example, here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1271935 Fama-French approach was used by Carhart (introduced momentum), Pastor-Stambaugh (introduced liquidity), Fama-French themselves (used it to build 5-factor model), and many other (elsevier or google for "fama french factor model").

Fama-MacBeth approach was used in Chen, Roll, Ross, 1986, which is believed to be quite important paper for APT.

There is also PCA approach to modelling asset returns. See, e.g., Luedecke, 1984, Connor and Korajczyk, 1988.

In industry, still, scholar models are not used. Practitioners develop their own models, sometimes kept as closely held secret, sometimes - made available to public (BARRA, CSFB, Morgan Stanley, Salomon-Smith-Barney, Bloomberg). Sometimes these models are just overcomplicated versions of scholar models, built with the same approaches. Sometimes they try to use some combination, for example Bloomberg family of models combine PCA with macro- and fundamental approaches.