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Assessing Specification Errors in Stochastic Discount Factor Models

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  • Lars Peter Hansen
  • Ravi Jagannathan

Abstract

In this paper we develop alternative ways to compare asset pricing models when it is understood that their implied stochastic discount factors do not price all portfolios correctly. Unlike comparisons based on x2 statistics associated with null hypothesis that models are correct, our measures of model performance do not reward variability of discount factor proxies. One of our measures is designed to exploit fully the implications of arbitrage-free pricing of derivative claims. We demonstrate empirically the usefulness of methods in assessing some alternative stochastic factor models that have been proposed in asset pricing literature.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0153.

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Date of creation: Feb 1994
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Publication status: published as Journal of Finance, Vol. 52, no. 2 (June 1997): 557-590.
Handle: RePEc:nbr:nberte:0153

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