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

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  • 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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