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A skeptical appraisal of asset pricing tests

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  • Lewellen, Jonathan
  • Nagel, Stefan
  • Shanken, Jay

Abstract

It has become standard practice in the cross-sectional asset pricing literature to evaluate models based on how well they explain average returns on size-B/M portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that asset pricing tests are often highly misleading, in the sense that apparently strong explanatory power (high cross-sectional R2s and small pricing errors) can provide quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models do not work as well as originally advertised.

Suggested Citation

  • Lewellen, Jonathan & Nagel, Stefan & Shanken, Jay, 2010. "A skeptical appraisal of asset pricing tests," Journal of Financial Economics, Elsevier, vol. 96(2), pages 175-194, May.
  • Handle: RePEc:eee:jfinec:v:96:y:2010:i:2:p:175-194
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    More about this item

    Keywords

    Asset pricing Cross-sectional tests Power;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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