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Consistent estimation of the risk-return tradeoff in the presence of measurement error

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Author Info
Anisha Ghosh ()
Oliver Linton ()
Abstract

Prominent asset pricing models imply a linear, time-invariant relation between the equity premium and its conditional variance. We propose an approach to estimating this relation that overcomes some of the limitations of the existing literature. First, we do not require any functional form assumptions about the conditional moments. Second, the GMM approach is used to overcome the endogeneity problem inherent in the regression. Third, we correct for the measurement error arising because of using a proxy for the latent variance. The empirical findings reveal significant time-variation in the relation that coincide with structural break dates in the market-wide price-dividend ratio.

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Paper provided by Universidad Carlos III, Departamento de Economía in its series Economics Working Papers with number we094928.

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Date of creation: Jul 2009
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Handle: RePEc:cte:werepe:we094928

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Related research
Keywords: Bias-Correction; Measurement Error; Nonparametric Volatility; Return; Risk;

Find related papers by JEL classification:
C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Semiparametric and Nonparametric Methods
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

This paper has been announced in the following NEP Reports:

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  3. George M. Constantinides & Anisha Ghosh, 2008. "Asset Pricing Tests with Long Run Risks in Consumption Growth," NBER Working Papers 14543, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. LINTON, Olivier & PERRON, Benoît, 1999. "The Shape of the Risk Premium: Evidence from a Semiparametric Garch Model," Cahiers de recherche 9911, Universite de Montreal, Departement de sciences economiques. [Downloadable!]
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  13. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October. [Downloadable!] (restricted)
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  15. Ole E. Barndorff-Nielsen & Shephard, 2002. "Econometric analysis of realized volatility and its use in estimating stochastic volatility models," Journal Of The Royal Statistical Society Series B, Royal Statistical Society, vol. 64(2), pages 253-280. [Downloadable!] (restricted)
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  18. Lubos Pástor & Meenakshi Sinha & Bhaskaran Swaminathan, 2008. "Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital," Journal of Finance, American Finance Association, vol. 63(6), pages 2859-2897, December. [Downloadable!] (restricted)
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  19. Back, Kerry, 1991. "Asset pricing for general processes," Journal of Mathematical Economics, Elsevier, vol. 20(4), pages 371-395. [Downloadable!] (restricted)
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  22. Backus, David K & Gregory, Allan W, 1993. "Theoretical Relations between Risk Premiums and Conditional Variances," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(2), pages 177-85, April.
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  23. Anisha Ghosh & George Constantinides, 2008. "Asset Pricing Tests with Long Run Risks in Consumption Growth," FMG Discussion Papers dp609, Financial Markets Group. [Downloadable!] (restricted)
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