Misspecification-robust inference in linear asset pricing models with irrelevant risk factors
AbstractWe show that in misspecified models with useless factors (for example, factors that are independent of the returns on the test assets), the standard inference procedures tend to erroneously conclude, with high probability, that these irrelevant factors are priced and the restrictions of the model hold. Our proposed model selection procedure, which is robust to useless factors and potential model misspecification, restores the standard inference and proves to be effective in eliminating factors that do not improve the model's pricing ability. The practical relevance of our analysis is illustrated using simulations and empirical applications.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2013-09.
Length: 87 pages
Date of creation: 01 Oct 2013
Date of revision:
Find related papers by JEL classification:
- C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Raymond Kan & Cesare Robotti, 2006.
"Specification tests of asset pricing models using excess returns,"
2006-10, Federal Reserve Bank of Atlanta.
- Kan, Raymond & Robotti, Cesare, 2008. "Specification tests of asset pricing models using excess returns," Journal of Empirical Finance, Elsevier, vol. 15(5), pages 816-838, December.
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