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Improvement in Finite Sample Properties of the Hansen-Jagannathan Distance Test

Author

Listed:
  • Ren, Yu
  • Shimotsu, Katsumi

Abstract

Jagannathan andWang (1996) derive the asymptotic distribution of the Hansen-Jagannathan distance (HJ-distance) proposed by Hansen and Jagannathan (1997), and develop a specification test of asset pricing models based on the HJ-distance. While the HJ-distance has several desirable properties, Ahn and Gadarowski (2004) find that the specification test based on the HJ-distance overrejects correct models too severely in commonly used sample size to provide a valid test. This paper proposes to improve the finite sample properties of the HJ-distance test by applying the shrinkage method (Ledoit and Wolf, 2003) to compute its weighting matrix. The proposed method improves the finite sample performance of the HJ-distance test significantly.

Suggested Citation

  • Ren, Yu & Shimotsu, Katsumi, 2007. "Improvement in Finite Sample Properties of the Hansen-Jagannathan Distance Test," Queen's Economics Department Working Papers 273602, Queen's University - Department of Economics.
    • Handle: RePEc:ags:quedwp:273602
    DOI: 10.22004/ag.econ.273602
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    Cited by:

    1. is not listed on IDEAS
    2. Colacito, Riccardo & Riddiough, Steven J. & Sarno, Lucio, 2020. "Business cycles and currency returns," Journal of Financial Economics, Elsevier, vol. 137(3), pages 659-678.
    3. Ikeda, Yuki & Kubokawa, Tatsuya, 2016. "Linear shrinkage estimation of large covariance matrices using factor models," Journal of Multivariate Analysis, Elsevier, vol. 152(C), pages 61-81.
    4. repec:wyi:journl:002162 is not listed on IDEAS
    5. Olivier Ledoit & Michael Wolf, 2019. "The power of (non-)linear shrinking: a review and guide to covariance matrix estimation," ECON - Working Papers 323, Department of Economics - University of Zurich, revised Feb 2020.
    6. Pasquale Della Corte & Steven J. Riddiough & Lucio Sarno, 2016. "Currency Premia and Global Imbalances," The Review of Financial Studies, Society for Financial Studies, vol. 29(8), pages 2161-2193.
    7. Yuki Ikeda & Tatsuya Kubokawa, 2015. "Linear Shrinkage Estimation of Large Covariance Matrices with Use of Factor Models," CIRJE F-Series CIRJE-F-958, CIRJE, Faculty of Economics, University of Tokyo.
    8. Romano, Joseph P. & Wolf, Michael, 2013. "Testing for monotonicity in expected asset returns," Journal of Empirical Finance, Elsevier, vol. 23(C), pages 93-116.
    9. Pasquale Della Corte & Steven J. Riddiough & Lucio Sarno, 2016. "Currency Premia and Global Imbalances," Review of Financial Studies, Society for Financial Studies, vol. 29(8), pages 2161-2193.
    10. Qihui Chen & Yu Ren, 2013. "Improvement in finite-sample properties of GMM-based Wald tests," Computational Statistics, Springer, vol. 28(2), pages 735-749, April.

    More about this item

    Keywords

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    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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