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Improvement in finite sample properties of the Hansen-Jagannathan distance test

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  • Ren, Yu
  • Shimotsu, Katsumi

Abstract

Jagannathan and Wang [Jagannthan, R., and Wang, Z., "The conditional CAPM and the cross-section of expected returns." Journal of Finance, 51 (1996), 3-53] derive the asymptotic distribution of the Hansen-Jagannathan distance (HJ-distance) proposed by Hansen and Jagannathan [Hansen, L.P., and Jagannathan, R., Assessing specific errors in stochastic discount factor models." Journal of Finance, 52 (1997), 557-590], and develop a specification test of asset pricing models based on the HJ-distance. While the HJ-distance has several desirable properties, Ahn and Gadarowski [Ahn, S.C., and Gadarowski, C., "Small sample properties of the GMM specification test based on the Hansen-Jagannathan distance." Journal of Empirical Finance, 11 (2004), 109-132] find that the specification test based on the HJ-distance overrejects correct models too severely in commonly used sample size to provide a valid test. This paper proposes to improve the finite sample properties of the HJ-distance test by applying the shrinkage method [Ledoit, O., and Wolf, M., "Improved estimation of the covariance matrix of stock returns with an application to portfolio selection." Journal of Empirical Finance, 10 (2003), 603-621] to compute its weighting matrix. The proposed method improves the finite sample performance of the HJ-distance test significantly.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 16 (2009)
Issue (Month): 3 (June)
Pages: 483-506

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Handle: RePEc:eee:empfin:v:16:y:2009:i:3:p:483-506

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Web page: http://www.elsevier.com/locate/jempfin

Related research

Keywords: Covariance matrix estimation Factor models Finite sample properties Hansen-Jagannathan distance Shrinkage method;

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References

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Cited by:
  1. Qihui Chen & Yu Ren, 2013. "Improvement in finite-sample properties of GMM-based Wald tests," Computational Statistics, Springer, vol. 28(2), pages 735-749, April.
  2. repec:wyi:journl:002162 is not listed on IDEAS

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