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Evaluating asset-pricing models using the Hansen-Jagannathan bound: a Monte Carlo investigation

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  • Christopher Otrok

    (Department of Economics, P.O. Box 400182, 114 Rouss Hall, The University of Virginia, Charlottesville, VA 22904-4182, USA)

  • B. Ravikumar

    (Department of Economics, 108 Pappajohn Business Building, The University of Iowa, Iowa City, IA 52242-1000, USA)

  • Charles H. Whiteman

    (Department of Economics, 108 Pappajohn Business Building, The University of Iowa, Iowa City, IA 52242-1000, USA)

Abstract

We use recent statistical tests, based on a 'distance' between the model and the Hansen-Jagannathan bound, to compute the rejection rates of true models. For asset-pricing models with time-separable preferences, the finite-sample distribution of the test statistic associated with the risk-neutral case is extreme, in the sense that critical values based on this distribution deliver type I errors no larger than intended-regardless of risk aversion or the rate of time preference. We also show that these maximal-type-I-error critical values are appropriate for both time and state non-separable preferences and that they yield acceptably small type II error rates. Copyright © 2002 John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 17 (2002)
Issue (Month): 2 ()
Pages: 149-174

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Handle: RePEc:jae:japmet:v:17:y:2002:i:2:p:149-174

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  1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  2. Andrew B. Abel, 1991. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
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  7. 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.
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  10. Heaton, John, 1995. "An Empirical Investigation of Asset Pricing with Temporally Dependent Preference Specifications," Econometrica, Econometric Society, vol. 63(3), pages 681-717, May.
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  13. Cochrane, John H. & Campbell, John, 1999. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Scholarly Articles 3119444, Harvard University Department of Economics.
  14. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1994. " Testing Volatility Restrictions on Intertemporal Marginal Rates of Substitution Implied by Euler Equations and Asset Returns," Journal of Finance, American Finance Association, vol. 49(1), pages 123-52, March.
  15. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
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  17. Otrok, Christopher & Ravikumar, B. & Whiteman, Charles H., 2002. "Habit formation: a resolution of the equity premium puzzle?," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1261-1288, September.
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Cited by:
  1. Raymond Kan & Cesare Robotti, 2008. "The exact distribution of the Hansen-Jagannathan bound," Working Paper 2008-09, Federal Reserve Bank of Atlanta.
  2. Silos, Pedro, 2006. "Assessing Markov chain approximations: A minimal econometric approach," Journal of Economic Dynamics and Control, Elsevier, vol. 30(6), pages 1063-1079, June.
  3. Otrok, Christopher & Ravikumar, B & Whiteman, Charles, 2001. "Stochastic Discount Factor Models and the Equity Premium Puzzle," MPRA Paper 22938, University Library of Munich, Germany, revised Nov 2004.
  4. Houssa, Romain, 2013. "Uncertainty about welfare effects of consumption fluctuations," European Economic Review, Elsevier, vol. 59(C), pages 35-62.

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