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An Exact Bayes Test of Asset Pricing Models with Application to International Markets

Author

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  • Doron Avramov

    (University of Maryland)

  • John C. Chao

    (University of Maryland)

Abstract

This paper develops and implements an exact finite-sample test of asset pricing models with time-varying risk premia using posterior probabilities. The strength of our approach is that it allows multiple conditional asset pricing specifications, both nested and nonnested, to be tested and compared simultaneously. We apply our procedure to international equity markets by testing and comparing the international Capital Asset Pricing Model (ICAPM) and conditional ICAPM versions of Fama and French (1998). The empirical evidence suggests that the best performing model is the ICAPM with the value premium constructed based on global earnings-to-price ratio.

Suggested Citation

  • Doron Avramov & John C. Chao, 2006. "An Exact Bayes Test of Asset Pricing Models with Application to International Markets," The Journal of Business, University of Chicago Press, vol. 79(1), pages 293-324, January.
    • Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:1:p:293-324
    DOI: 10.1086/497412
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    Citations

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    Cited by:

    1. Glabadanidis, Paskalis, 2009. "Measuring the economic significance of mean-variance spanning," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(2), pages 596-616, May.
    2. Constantinos Kardaras & Hyeng Keun Koo & Johannes Ruf, 2022. "Estimation of growth in fund models," Papers 2208.02573, arXiv.org.
    3. Henkel, Sam James & Martin, J. Spencer & Nardari, Federico, 2011. "Time-varying short-horizon predictability," Journal of Financial Economics, Elsevier, vol. 99(3), pages 560-580, March.
    4. Erik Kole & Reza Brink, "undated". "Constructing and Using Double-adjusted Alphas to Analyze Mutual Fund Performance," Tinbergen Institute Discussion Papers 19-029/IV, Tinbergen Institute.
    5. Francisco Barillas & Jay Shanken, 2017. "Which Alpha?," The Review of Financial Studies, Society for Financial Studies, vol. 30(4), pages 1316-1338.
    6. Borup, Daniel, 2019. "Asset pricing model uncertainty," Journal of Empirical Finance, Elsevier, vol. 54(C), pages 166-189.
    7. Doron Avramov & Si Cheng & Lior Metzker & Stefan Voigt, 2023. "Integrating Factor Models," Journal of Finance, American Finance Association, vol. 78(3), pages 1593-1646, June.
    8. Manuel Ammann & Michael Verhofen, 2008. "Testing Conditional Asset Pricing Models Using a Markov Chain Monte Carlo Approach," European Financial Management, European Financial Management Association, vol. 14(3), pages 391-418, June.
    9. Smith, Simon C., 2022. "Time-variation, multiple testing, and the factor zoo," International Review of Financial Analysis, Elsevier, vol. 84(C).
    10. Francisco Barillas & Jay Shanken, 2018. "Comparing Asset Pricing Models," Journal of Finance, American Finance Association, vol. 73(2), pages 715-754, April.
    11. Malefaki, Valia, 2015. "On Flexible Linear Factor Stochastic Volatility Models," MPRA Paper 62216, University Library of Munich, Germany.

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