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Evaluation of linear asset pricing models by implied portfolio performance

Listed author(s):
  • Balvers, Ronald J.
  • Huang, Dayong

We present a theoretical perspective that motivates the use of the Generalized Least Squares R-Square, prominently advocated by Lewellen et al. [Lewellen, J., Nagel, S., Shanken, J., forthcoming. A skeptical appraisal of asset-pricing tests. Journal of Financial Economics], as an evaluation measure for multivariate linear asset pricing models. Adapting results from Shanken [Shanken, J., 1985. Multivariate tests of the zero-beta CAPM. Journal of Financial Economics 14, 327-348] and Kandel and Stambaugh [Kandel, S., Stambaugh, R.F., 1995. Portfolio inefficiency and the cross-section of expected returns. Journal of Finance 50, 157-184], we provide various interpretations and a graphical account in mean-variance space of this measure, facilitating a better understanding of its properties. We furthermore relate it to another leading evaluation metric, the HJ-distance of Hansen and Jagannathan [Hansen, L.P., Jagannathan, R., 1997. Assessing specification errors in stochastic discount factor models. Journal of Finance 52, 557-590]. Additionally, we present a comparison between these evaluation measures using mean-variance mathematics in risk-return space, and we provide a simple formula for calculating both model evaluation measures that involves only the parameters of the mean-variance asset and factor frontiers.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 33 (2009)
Issue (Month): 9 (September)
Pages: 1586-1596

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Handle: RePEc:eee:jbfina:v:33:y:2009:i:9:p:1586-1596
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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