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Comparing Asset Pricing Models: An Investment Perspective

  • Lubos Pastor
  • Robert F. Stambaugh

We investigate the portfolio choices of mean-variance-optimizing investors who use sample evidence to update prior beliefs centered on either risk-based or characteristic-based pricing models. With dogmatic beliefs in such models and an unconstrained ratio of position size to capital, optimal portfolios can differ across models to economically significant degrees. The differences are substantially reduced by modest uncertainty about the models' pricing abilities. When the ratio of position size to capital is subject to realistic constraints, the differences in portfolios across models become even less important, nonexistent in some cases.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 16-99.

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Handle: RePEc:fth:pennfi:16-99
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  1. Daniel, Kent & Titman, Sheridan, 1997. " Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, vol. 52(1), pages 1-33, March.
  2. Grinblatt, Mark & Titman, Sheridan, 1987. "The Relation between Mean-Variance Efficiency and Arbitrage Pricing," The Journal of Business, University of Chicago Press, vol. 60(1), pages 97-112, January.
  3. Ingersoll, Jonathan E, Jr, 1984. " Some Results in the Theory of Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 39(4), pages 1021-39, September.
  4. Lubos Pástor & Robert F. Stambaugh, . "Costs of Equity Capital and Model Mispricing," Rodney L. White Center for Financial Research Working Papers 4-98, Wharton School Rodney L. White Center for Financial Research.
  5. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  6. Kandel, S. & McCulloch, R. & Stambaugh, R.F., 1991. "Bayesian Inference and Portfolio Efficiency," Weiss Center Working Papers 8-91, Wharton School - Weiss Center for International Financial Research.
  7. Klein, Roger W. & Bawa, Vijay S., 1976. "The effect of estimation risk on optimal portfolio choice," Journal of Financial Economics, Elsevier, vol. 3(3), pages 215-231, June.
  8. A. Craig MacKinlay & Lubos Pastor, . "Asset Pricing Models: Implications for Expected Returns and Portfolio Selection," Rodney L. White Center for Financial Research Working Papers 13-99, Wharton School Rodney L. White Center for Financial Research.
  9. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
  10. Wang, Zhenyu, 1998. "Efficiency loss and constraints on portfolio holdings," Journal of Financial Economics, Elsevier, vol. 48(3), pages 359-375, June.
  11. Nicholas G. Polson & George C. Tiao (ed.), 1995. "Bayesian Inference," Books, Edward Elgar, volume 0, number 602, March.
  12. Kandel, Shmuel & Stambaugh, Robert F, 1996. " On the Predictability of Stock Returns: An Asset-Allocation Perspective," Journal of Finance, American Finance Association, vol. 51(2), pages 385-424, June.
  13. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
  14. Shanken, Jay, 1987. "A Bayesian approach to testing portfolio efficiency," Journal of Financial Economics, Elsevier, vol. 19(2), pages 195-215, December.
  15. 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.
  16. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  17. Huberman, Gur & Kandel, Shmuel & Stambaugh, Robert F, 1987. " Mimicking Portfolios and Exact Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 42(1), pages 1-9, March.
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