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Empirical evaluation of overspecified asset pricing models

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  • Manresa, Elena
  • Peñaranda, Francisco
  • Sentana, Enrique

Abstract

Empirical asset pricing models with possibly unnecessary risk factors are increasingly common. Unfortunately, they can yield misleading statistical inferences. Unlike previous studies, we estimate the identified set of SDFs and risk prices compatible with a given model’s asset pricing restrictions. We also propose tests that detect problematic situations with economically meaningless SDFs unrelated to the test assets. Empirically, we estimate linear subspaces of SDFs compatible with popular extensions of the traditional and consumption versions of the CAPM, which are typically two-dimensional. Moreover, we often find that all the SDFs in those linear spaces are uncorrelated with the test assets’ returns.

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  • Manresa, Elena & Peñaranda, Francisco & Sentana, Enrique, 2023. "Empirical evaluation of overspecified asset pricing models," Journal of Financial Economics, Elsevier, vol. 147(2), pages 338-351.
    • Handle: RePEc:eee:jfinec:v:147:y:2023:i:2:p:338-351
    DOI: 10.1016/j.jfineco.2022.10.002
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    Cited by:

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    5. Laurinaityte, Nora & Meinerding, Christoph & Schlag, Christian & Thimme, Julian, 2024. "GMM weighting matrices in cross-sectional asset pricing tests," Journal of Banking & Finance, Elsevier, vol. 162(C).

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    More about this item

    Keywords

    Continuously updated GMM; Factor pricing models; Set estimation; Stochastic discount factor; Underidentification tests;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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