Advanced Search
MyIDEAS: Login to save this paper or follow this series

Evaluating Asset-Pricing Models Using The Hansen-Jagannathan Bound: A Monte Carlo Investigation

Contents:

Author Info

  • Christopher Otrok

    ()

  • B. Ravikumar

    ()

  • Charles H. Whiteman

    ()

Abstract

We conduct Monte Carlo experiments to examine whether the bound proposed by Hansen and Jagannathan (1991) is a useful device for evaluating asset pricing models. Specifically, we use recently developed statistical tests, which are based on a 'distance' between the model and the Hansen-Jagannathan bound, to compute the rejection rates of true models. We provide finite-sample critical values for asset pricing models with time separable preferences, and show how they depend upon nuisance parameters—risk aversion and the rate of time preference. Further, we show that the finite-sample distribution of the test statistic associated with the risk-neutral case is extreme, in the sense that critical values based on this distribution will deliver type I errors no larger than intended—regardless of risk aversion or the rate of time preference. Extending the analysis to accommodate other preferences, we show that in the state non-separable case, the small-sample distributions of the test statistics are influenced significantly by the degree of intertemporal substitution, but not by attitudes toward risk. For habit formation preferences, the small-sample distributions are strongly influenced by the habit parameter. However, the maximal-size critical values for time-separable preferences are appropriate for habit formation as well as state non-separable preferences. We conclude that with these critical values the HJ bound is indeed a useful evaluation device. We then use the critical values to evaluate three asset pricing models using U.S. data. We find evidence against the time-separable model and mixed evidence on the remaining two models.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.virginia.edu/economics/RePEc/vir/virpap/papers/virpap350.pdf
Download Restriction: no

Bibliographic Info

Paper provided by University of Virginia, Department of Economics in its series Virginia Economics Online Papers with number 350.

as in new window
Length: 28 pages
Date of creation: Aug 2000
Date of revision:
Handle: RePEc:vir:virpap:350

Contact details of provider:
Web page: http://www.virginia.edu/economics/home.html

Related research

Keywords:

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
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.:
as in new window
  1. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers, Wharton School - Weiss Center for International Financial Research 1-90, Wharton School - Weiss Center for International Financial Research.
  2. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(3), pages 519-43, June.
  3. Hansen, Lars Peter & Heaton, John & Luttmer, Erzo G J, 1995. "Econometric Evaluation of Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 8(2), pages 237-74.
  4. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing Specification Errors in Stochastic Discount Factor Models," NBER Technical Working Papers, National Bureau of Economic Research, Inc 0153, National Bureau of Economic Research, Inc.
  5. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
  6. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  7. Otrok, Christopher & Ravikumar, B. & Whiteman, Charles H., 2002. "Habit formation: a resolution of the equity premium puzzle?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(6), pages 1261-1288, September.
  8. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, Econometric Society, vol. 50(5), pages 1269-86, September.
  9. John H. Cochrane & Lars Peter Hansen, 1992. "Asset Pricing Explorations for Macroeconomics," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 1992, Volume 7, pages 115-182 National Bureau of Economic Research, Inc.
  10. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
  11. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1994. " Testing Volatility Restrictions on Intertemporal Marginal Rates of Substitution Implied by Euler Equations and Asset Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 49(1), pages 123-52, March.
  12. Lars Peter Hansen & Ravi Jagannathan, 1990. "Implications of security market data for models of dynamic economies," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 29, Federal Reserve Bank of Minneapolis.
  13. Abel, Andrew B., 1999. "Risk premia and term premia in general equilibrium," Journal of Monetary Economics, Elsevier, Elsevier, vol. 43(1), pages 3-33, February.
  14. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  15. Gregory, Allan W. & Smith, Gregor W., 1992. "Sampling variability in Hansen-Jagannathan bounds," Economics Letters, Elsevier, Elsevier, vol. 38(3), pages 263-267, March.
  16. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 107(2), pages 205-251, April.
  17. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, Econometric Society, vol. 57(4), pages 937-69, July.
  18. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, Elsevier, vol. 20(2), pages 177-181.
  19. Heaton, John, 1995. "An Empirical Investigation of Asset Pricing with Temporally Dependent Preference Specifications," Econometrica, Econometric Society, Econometric Society, vol. 63(3), pages 681-717, May.
  20. Burnside, Craig, 1994. "Hansen-Jagannathan Bounds as Classical Tests of Asset-Pricing Models," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 12(1), pages 57-79, January.
  21. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, Econometric Society, vol. 50(4), pages 1029-54, July.
  22. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1429-45, November.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Raymond Kan & Cesare Robotti, 2008. "The exact distribution of the Hansen-Jagannathan bound," Working Paper, Federal Reserve Bank of Atlanta 2008-09, Federal Reserve Bank of Atlanta.
  2. Houssa, Romain, 2013. "Uncertainty about welfare effects of consumption fluctuations," European Economic Review, Elsevier, Elsevier, vol. 59(C), pages 35-62.
  3. Otrok, Christopher & Ravikumar, B & Whiteman, Charles, 2001. "Stochastic Discount Factor Models and the Equity Premium Puzzle," MPRA Paper 22938, University Library of Munich, Germany, revised Nov 2004.
  4. Qiang Zhang, 2004. "Accounting for Human Capital and Weak Identification in Evaluating the Esptein-Zin-Weil Non-Expected Utility Model of Asset Pricing," CIRJE F-Series, CIRJE, Faculty of Economics, University of Tokyo CIRJE-F-289, CIRJE, Faculty of Economics, University of Tokyo.
  5. Silos, Pedro, 2006. "Assessing Markov chain approximations: A minimal econometric approach," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 30(6), pages 1063-1079, June.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:vir:virpap:350. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Debby Stanford).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.