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A Unifying Approach to the Empirical Evaluation of Asset Pricing Models

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  • Francisco Peñaranda
  • Enrique Sentana

Abstract

Two main approaches are commonly used to empirically evaluate linear factor pricing models: regression and SDF methods, with centred and uncentred versions of the latter. We show that unlike standard two-step or iterated GMM procedures, single-step estimators such as continuously updated GMM yield numerically identical values for prices of risk, pricing errors, Jensens alphas and overidentifying restrictions tests irrespective of the model validity. Therefore, there is arguably a single approach regardless of the factors being traded or not, or the use of excess or gross returns. We illustrate our results by revisiting Lustig and Verdelhans (2007).

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 488.

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Date of creation: Jul 2010
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Handle: RePEc:bge:wpaper:488

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Keywords: CU-GMM; Factor pricing models; Forward premium puzzle; Generalised Empirical Likelihood; Stochastic discount factor;

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  1. Enrique Sentana & Francisco Penaranda, 2004. "Spanning Tests in Return and Stochastic Discount Factor Mean-Variance Frontiers: A Unifying Approach," FMG Discussion Papers, Financial Markets Group dp497, Financial Markets Group.
  2. Owen, Joel & Rabinovitch, Ramon, 1983. " On the Class of Elliptical Distributions and Their Applications to the Theory of Portfolio Choice," Journal of Finance, American Finance Association, American Finance Association, vol. 38(3), pages 745-52, June.
  3. Lewellen, Jonathan & Nagel, Stefan & Shanken, Jay, 2010. "A skeptical appraisal of asset pricing tests," Journal of Financial Economics, Elsevier, Elsevier, vol. 96(2), pages 175-194, May.
  4. Antoine, Bertille & Bonnal, Helene & Renault, Eric, 2007. "On the efficient use of the informational content of estimating equations: Implied probabilities and Euclidean empirical likelihood," Journal of Econometrics, Elsevier, Elsevier, vol. 138(2), pages 461-487, June.
  5. Anisha Ghosh & Christian Julliard, 2008. "Can Rare Events Explain the Equity Premium Puzzle?," 2008 Meeting Papers 1090, Society for Economic Dynamics.
  6. Robert M. De Jong & James Davidson, 2000. "Consistency of Kernel Estimators of Heteroscedastic and Autocorrelated Covariance Matrices," Econometrica, Econometric Society, Econometric Society, vol. 68(2), pages 407-424, March.
  7. Kan, Raymond & Robotti, Cesare, 2008. "Specification tests of asset pricing models using excess returns," Journal of Empirical Finance, Elsevier, Elsevier, vol. 15(5), pages 816-838, December.
  8. Hanno Lustig & Adrien Verdelhan, 2004. "The Cross-Section of Foreign Currency Risk Premia and US Consumption Growth Risk," 2004 Meeting Papers, Society for Economic Dynamics 136c, Society for Economic Dynamics.
  9. Motohiro Yogo, 2006. "A Consumption-Based Explanation of Expected Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 61(2), pages 539-580, 04.
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Cited by:
  1. Francisco Peñaranda & Enrique Sentana, 2008. "Spanning tests in return and stochastic discount factor mean-variance frontiers: A unifying approach," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1101, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2010.

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