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Conditioning Information and Variance Bounds on Pricing Kernels

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  • Geert Bekaert
  • Jun Liu

Abstract

We show how to use conditioning information optimally to construct a sharper unconditional Hansen-Jagannathan (1991) bound. The approach in this paper is different from that of Gallant, Hansen and Tauchen (1990), but both approaches yield the same bound when the conditional moments are known. Unlike Gallant, Hansen and Tauchen, our approach is robust to misspecification of the first and second conditional moments. Potential applications include testing dynamic asset pricing models, studying the predictability of asset returns, diagnosing the accuracy of competing models for the first and second conditional moments of asset returns, dynamic asset allocation and mutual fund performance measurement. The illustration in this article starts with the familiar Hansen-Singleton (1983) setup of an autoregressive model for consumption growth and bond and stock returns. Our innovation is to add time-varying volatility to the model. Both an unconstrained version and a version with the restrictions of the standard consumption-based asset pricing model imposed serve as the data-generating processes to illustrate the behavior of the bounds. In the process, we discover and explore an interesting empirical phenomenon: asymmetric volatility in consumption growth.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6880.

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Date of creation: Jan 1999
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Publication status: published as Bekaert, Geert and Jun Liu. "Conditioning Information And Variance Bounds On Pricing Kernels," Review of Financial Studies, 2004, v17(2,Summer), 339-378.
Handle: RePEc:nbr:nberwo:6880

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  1. Bekaert, Geert & Hodrick, Robert J, 1992. " Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June.
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