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Assessing specification errors in stochastic discount factor models

Author

Listed:
  • Lars Peter Hansen
  • Ravi Jagannathan

Abstract

In this paper we develop alternative ways to compare asset pricing models when it is understood that their implied stochastic discount factors do not price all portfolios correctly. Unlike comparisons based on chi-squared statistics associated with null hypotheses that models are correct, our measures of model performance do not reward variability of discount factor proxies. One of our measures is designed to exploit fully the implications of arbitrage-free pricing of derivative claims. We demonstrate empirically the usefulness of methods in assessing some alternative stochastic factor models that have been proposed in asset pricing literature.

Suggested Citation

  • Lars Peter Hansen & Ravi Jagannathan, . "Assessing specification errors in stochastic discount factor models," Staff Report, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:167
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    References listed on IDEAS

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    Cited by:

    1. Jagannathan, Ravi & Kubota, Keiichi & Takehara, Hitoshi, 1998. "Relationship between Labor-Income Risk and Average Return: Empirical Evidence from the Japanese Stock Market," The Journal of Business, University of Chicago Press, vol. 71(3), pages 319-347, July.
    2. Nick Durack & Robert B. Durand & Ross A. Maller, 2004. "A best choice among asset pricing models? The Conditional Capital Asset Pricing Model in Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 44(2), pages 139-162, July.
    3. Michael Bond & Michael Seiler, 1998. "Real Estate Returns and Inflation: An Added Variable Approach," Journal of Real Estate Research, Taylor & Francis Journals, vol. 15(3), pages 327-338, January.
    4. MacKinlay, A. Craig, 1995. "Multifactor models do not explain deviations from the CAPM," Journal of Financial Economics, Elsevier, vol. 38(1), pages 3-28, May.
    5. Wayne E. Ferson & Ravi Jagannathan, . "Econometric evaluation of asset pricing models," Staff Report, Federal Reserve Bank of Minneapolis.
    6. Liu, Yan, 2021. "Index option returns and generalized entropy bounds," Journal of Financial Economics, Elsevier, vol. 139(3), pages 1015-1036.
    7. Aziz, Andrew R. & Prisman, Eliezer Z., 2000. "After-tax term structures of real interest rates: Inferences from the UK linked and non-linked gilt markets," Journal of Banking & Finance, Elsevier, vol. 24(9), pages 1433-1455, September.
    8. Bakshi, Gurdip S. & Naka, Atsuyuki, 1997. "An empirical investigation of asset pricing models using Japanese stock market data," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 81-112, February.
    9. Kasa, Kenneth, 1997. "Consumption-based versus production-based models of international equity markets," Journal of International Money and Finance, Elsevier, vol. 16(5), pages 653-680, September.

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    More about this item

    Keywords

    capital asset pricing model;

    JEL classification:

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

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