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A Skeptical Appraisal of Asset-Pricing Tests

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  • Jonathan Lewellen
  • Stefan Nagel
  • Jay Shanken

Abstract

It has become standard practice in the cross-sectional asset-pricing literature to evaluate models based on how well they explain average returns on size- and B/M-sorted portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that asset-pricing tests are often highly misleading, in the sense that apparently strong explanatory power (high cross-sectional R2s and small pricing errors) in fact provides quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models don%u2019t work as well as originally advertised.

Suggested Citation

  • Jonathan Lewellen & Stefan Nagel & Jay Shanken, 2006. "A Skeptical Appraisal of Asset-Pricing Tests," NBER Working Papers 12360, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12360
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    JEL classification:

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

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