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Abstract

This paper examines the specification errors of several asset pricing models using the methodology of Hansen and Jagannathan (1997) and a common data set. The models are the CAPM, the Consumption CAPM, the Jagannathan and Wang (1996) conditional CAPM, the Campbell (1996) dynamic asset pricing model, the Cochrane (1996) production-based model, and the Fama-French (1993) three-factor and five-factor models. We use returns on the Fama-French twenty-five portfolios sorted by size and book-to-market ratio and the risk-free rate as our test assets. The sample is 1952 to 1997. We allow the parameters of the models' pricing kernels to fluctuate with the business cycle which we measure in two ways. One uses the Hodrick-Prescott (1997) filter applied to either industrial production for monthly models or real GNP for quarterly models. The second approach for quarterly models uses the consumption-wealth measure developed by Lettau and Ludvigson (1999). While we cannot reject correct pricing for Campbell's model, a stability test indicates that the parameters may not be stable. None of the models correctly prices returns that are scaled by the term premium.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 62 (2001)
Issue (Month): 2 (November)
Pages: 327-376

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Handle: RePEc:eee:jfinec:v:62:y:2001:i:2:p:327-376

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Web page: http://www.elsevier.com/locate/inca/505576

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Find related papers by JEL classification:

• G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
• E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

References

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1. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
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5. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
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   • Hansen, Lars Peter & Jagannathan, Ravi, 1997. " Assessing Specification Errors in Stochastic Discount Factor Models," Journal of Finance, American Finance Association, vol. 52(2), pages 557-90, June.
   • Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing specification errors in stochastic discount factor models," Staff Report 167, Federal Reserve Bank of Minneapolis.
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    • Martin Lettau & Sydney Ludvigson, 1999. "Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying," Staff Reports 93, Federal Reserve Bank of New York.
11. Loughran, Tim, 1997. "Book-to-Market across Firm Size, Exchange, and Seasonality: Is There an Effect?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(03), pages 249-268, September.
12. Daniel, Kent & Titman, Sheridan, 1997. " Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, vol. 52(1), pages 1-33, March.
    
    • Kent Daniel & Sheridan Titman, 1996. "Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," NBER Working Papers 5604, National Bureau of Economic Research, Inc.
13. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
14. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    
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20. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-56, July.
    
    • Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation for Research in Economics, Yale University.
21. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
22. Brennan, Michael J. & Chordia, Tarun & Subrahmanyam, Avanidhar, 1998. "Alternative factor specifications, security characteristics, and the cross-section of expected stock returns," Journal of Financial Economics, Elsevier, vol. 49(3), pages 345-373, September.
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