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Evaluating asset-pricing models using the Hansen-Jagannathan bound: a Monte Carlo investigation

  • Christopher Otrok

    (Department of Economics, P.O. Box 400182, 114 Rouss Hall, The University of Virginia, Charlottesville, VA 22904-4182, USA)

  • B. Ravikumar

    (Department of Economics, 108 Pappajohn Business Building, The University of Iowa, Iowa City, IA 52242-1000, USA)

  • Charles H. Whiteman

    (Department of Economics, 108 Pappajohn Business Building, The University of Iowa, Iowa City, IA 52242-1000, USA)

We use recent statistical tests, based on a 'distance' between the model and the Hansen-Jagannathan bound, to compute the rejection rates of true models. For asset-pricing models with time-separable preferences, 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 deliver type I errors no larger than intended-regardless of risk aversion or the rate of time preference. We also show that these maximal-type-I-error critical values are appropriate for both time and state non-separable preferences and that they yield acceptably small type II error rates. Copyright © 2002 John Wiley & Sons, Ltd.

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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 17 (2002)
Issue (Month): 2 ()
Pages: 149-174

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Handle: RePEc:jae:japmet:v:17:y:2002:i:2:p:149-174
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