Model comparison using the Hansen-Jagannathan distance
Abstract
Although it is of interest to empirical researchers to test whether or not a particular asset-pricing model is true, a more useful task is to determine how wrong a model is and to compare the performance of competing asset-pricing models. In this paper, we propose a new methodology to test whether two competing linear asset-pricing models have the same Hansen-Jagannathan distance. We show that the asymptotic distribution of the test statistic depends on whether the competing models are correctly specified or misspecified and are nested or nonnested. In addition, given the increasing interest in misspecified models, we propose a simple methodology for computing the standard errors of the estimated stochastic discount factor parameters that are robust to model misspecification. Using the same data as in Hodrick and Zhang (2001), we show that the commonly used returns and factors are, for the most part, too noisy to conclude that one model is superior to the other models in terms of Hansen-Jagannathan distance. In addition, we show that many of the macroeconomic factors commonly used in the literature are no longer priced once potential model misspecification is taken into account.Download Info
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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2007-04.Length:
Date of creation: 2007
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Handle: RePEc:fip:fedawp:2007-04
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Keywords:Other versions of this item:
- Raymond Kan & Cesare Robotti, 2009. "Model Comparison Using the Hansen-Jagannathan Distance," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3449-3490, September.
- NEP-ALL-2007-03-31 (All new papers)
- NEP-ECM-2007-03-31 (Econometrics)
- NEP-RMG-2007-03-31 (Risk Management)
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Citations
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.Cited by:
- Raymond Kan & Cesare Robotti & Jay Shanken, 2009.
"Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology,"
NBER Working Papers
15047, National Bureau of Economic Research, Inc.
- Raymond Kan & Cesare Robotti & Jay Shanken, 2009. "Pricing model performance and the two-pass cross-sectional regression methodology," Working Paper 2009-11, Federal Reserve Bank of Atlanta.
- Sydney Ludvigson & Xiaohong Chen, 2004.
"Land of Addicts? An Empirical Investigation of Habit-Based Asset Pricing Models,"
2004 Meeting Papers
692, Society for Economic Dynamics.
- Xiaohong Chen & Sydney C. Ludvigson, 2009. "Land of addicts? an empirical investigation of habit-based asset pricing models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(7), pages 1057-1093.
- Barclay, Richard & Fletcher, Jonathan & Marshall, Andrew, 2010. "Pricing emerging market stock returns: An update," Emerging Markets Review, Elsevier, vol. 11(1), pages 49-61, March.
- Dovonon, Prosper, 2008. "Large sample properties of the three-step euclidean likelihood estimators under model misspecification," MPRA Paper 40025, University Library of Munich, Germany, revised 16 May 2010.
- Craig Burnside, 2010. "Identification and Inference in Linear Stochastic Discount Factor Models," NBER Working Papers 16634, National Bureau of Economic Research, Inc.
- Marmer, Vadim & Otsu, Taisuke, 2012.
"Optimal comparison of misspecified moment restriction models under a chosen measure of fit,"
Journal of Econometrics,
Elsevier, vol. 170(2), pages 538-550.
- Marmer, Vadim & Otsu, Taisuke, 2008. "Optimal Comparison of Misspecified Moment Restriction Models under a Chosen Measure of Fit," Micro Theory Working Papers vadim_marmer-2008-13, Microeconomics.ca Website, revised 25 Jul 2011.
- Vadim Marmer & Taisuke Otsu, 2009. "Optimal Comparison of Misspecified Moment Restriction Models under a Chosen Measure of Fit," Cowles Foundation Discussion Papers 1724, Cowles Foundation for Research in Economics, Yale University, revised Jul 2011.
- Carlos Enrique Carrasco Gutierrez & Wagner Piazza Gaglianone, 2008. "Evaluating Asset Pricing Models in a Fama-French Framework," Working Papers Series 175, Central Bank of Brazil, Research Department.
- Pierluigi Balduzzi & Cesare Robotti, 2005.
"Asset-pricing models and economic risk premia: a decomposition,"
Working Paper
2005-13, Federal Reserve Bank of Atlanta.
- Balduzzi, Pierluigi & Robotti, Cesare, 2010. "Asset pricing models and economic risk premia: A decomposition," Journal of Empirical Finance, Elsevier, vol. 17(1), pages 54-80, January.
- Nikolay Gospodinov & Raymond Kan & Cesare Robotti, 2012. "Analytical solution for the constrained Hansen-Jagannathan distance under multivariate ellipticity," Working Paper 2012-18, Federal Reserve Bank of Atlanta.
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