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Assessing Asset Pricing Model Misspecification With A Returns Decomposition
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Book Synopsis Assessing Asset Pricing Model Misspecification with a Returns Decomposition by : Stéphane Chrétien
Download or read book Assessing Asset Pricing Model Misspecification with a Returns Decomposition written by Stéphane Chrétien and published by . This book was released on 2002 with total page 48 pages. Available in PDF, EPUB and Kindle. Book excerpt: Asset returns implicitly contain information about the systematic and nonsystematic risks in an economy. Based solely on the law of one price condition, we extract this information by using a mean-variance frontier decomposition of returns, and exploit it to improve the assessment of specification errors of stochastic discount factor models. Our empirical results document a large and significant mispricing of both the systematic and nonsystematic risks in industry returns, even for models not rejected by a test of over-identifying restrictions. Furthermore, models with smaller pricing errors on the pervasive portion of returns generally obtain larger pricing errors on the idiosyncratic portion of returns. We explain why this tradeoff is likely to occur and how it affects the evaluation of asset pricing models.
Book Synopsis What to Do About a Latent Factor by : Todd Prono
Download or read book What to Do About a Latent Factor written by Todd Prono and published by . This book was released on 2015 with total page 48 pages. Available in PDF, EPUB and Kindle. Book excerpt: A new model misspecification measure for linear asset pricing models is proposed. The origins of this measure are in Shanken (1987) and Kandel and Stambaugh (1985, 1995), where it is argued that the true market return is inherently latent and, as a consequence, only ever partially observed. Tests of asset pricing models that rely on the market return as a risk factor and are based, by necessity, on an observable proxy to this factor are then misspecified. The proposed misspecification measure, which assigns an upper bound to the correlation between the true market return and the observable proxy return used to conduct the test, can be estimated entirely and directly from observable data. This measure is suited both for testing models that include the market return as a pricing factor in a traditional sense (i.e., determining whether the given model does or does not price a collection of risky assets) and ranking those models (i.e., gauging which model performs the best). The measure is used to price portfolios reflecting the size, value, and momentum premiums. While neither the conditional CAPM nor the ICAPM is shown to offer any improvement over the simple CAPM, all three models are shown to perform materially better under the proposed measure, with improvements in model fit of as much as 45%. Also, it is discovered that winner stocks in a momentum portfolio may have higher market betas than loser stocks.
Book Synopsis Assessing Misspecified Asset Pricing Models with Empirical Likelihood Estimators by : Caio Almeida
Download or read book Assessing Misspecified Asset Pricing Models with Empirical Likelihood Estimators written by Caio Almeida and published by . This book was released on 2009 with total page 44 pages. Available in PDF, EPUB and Kindle. Book excerpt: Hansen and Jagannathan (1997) compare misspecified asset pricing models based on least-square projections on a family of admissible stochastic discount factors. We extend their fundamental contribution by considering Minimum Discrepancy (MD) projections where misspecification is measured by convex functions that can explicitly take into account higher moments of asset returns. The MD problems are solved on dual spaces with the interpretation of optimal portfolio problems based on HARA utility functions, producing a family of estimators that captures the least-square problem as a particular case. We use our proposed methodology to test the Consumption Asset Pricing Model and illustrate, under several different discrepancy functions and regions of the parametric space, the relation between the parametric proxy model, and the closest admissible SDF. On the estimation problem, not surprisingly, all MD estimators clearly reject the CCAPM model. However, some of these estimators lead to admissible SDFs that are very distinct from the one implied by the least-square solution. By their pricing implications, this rich set of optimal MD SDFs represent useful tools to diagnose missing factors in asset pricing models.
Book Synopsis Robust Inference in Linear Asset Pricing Models by : Nikolay Gospodinov
Download or read book Robust Inference in Linear Asset Pricing Models written by Nikolay Gospodinov and published by . This book was released on 2016 with total page 90 pages. Available in PDF, EPUB and Kindle. Book excerpt: Many asset pricing models include risk factors that are only weakly correlated with the asset returns. We show that in the presence of a factor that is independent of the returns ("useless factor"), the standard inference procedures for evaluating its pricing ability could be highly misleading in misspecified models. Our proposed model selection procedure, which is robust to useless factors and potential model misspecification, restores the standard inference and proves to be effective in eliminating factors that do not improve the model's pricing ability. The practical relevance of our analysis is illustrated using simulations and an empirical application.
Book Synopsis An Evaluation of International Asset Pricing Models by : Magnus Dahlquist
Download or read book An Evaluation of International Asset Pricing Models written by Magnus Dahlquist and published by . This book was released on 2008 with total page 38 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper assesses the ability of international asset pricing models to explain the cross-sectional variation in expected returns. All the models considered seem to capture national market returns fairly well. However, global portfolios, sorted on earnings-price ratio and market value, pose a special challenge. We find that an unconditional international CAPM cannot explain the cross-sectional variation in these portfolio returns. Interestingly, a conditional international asset pricing model that includes foreign exchange risk factors is able to explain a large part of the variation in average returns. Our empirical work suggests that this model has the same explanatory ability as an international three-factor model, where zero-cost portfolios based on earnings-price ratios and market values are used in addition to the world market portfolio. Importantly, the loadings associated with the zero-cost portfolios are driven out by the characteristics themselves, indicating a misspecification.
Book Synopsis Misspecification-Robust Inference in Linear Asset Pricing Models with Irrelevant Risk Factors by : Nikolay Gospodinov
Download or read book Misspecification-Robust Inference in Linear Asset Pricing Models with Irrelevant Risk Factors written by Nikolay Gospodinov and published by . This book was released on 2015 with total page 87 pages. Available in PDF, EPUB and Kindle. Book excerpt: We show that in misspecified models with useless factors (for example, factors that are independent of the returns on the test assets), the standard inference procedures tend to erroneously conclude, with high probability, that these irrelevant factors are priced and the restrictions of the model hold. Our proposed model selection procedure, which is robust to useless factors and potential model misspecification, restores the standard inference and proves to be effective in eliminating factors that do not improve the model's pricing ability. The practical relevance of our analysis is illustrated using simulations and empirical applications.
Book Synopsis Assessing Asset Pricing Models Using Revealed Preference by : Jonathan Berk
Download or read book Assessing Asset Pricing Models Using Revealed Preference written by Jonathan Berk and published by . This book was released on 2020 with total page 48 pages. Available in PDF, EPUB and Kindle. Book excerpt: We propose a new method of testing asset pricing models that relies on using quantities rather than simply prices or returns. We use the capital flows into and out of mutual funds to infer which risk model investors use. We derive a simple test statistic that allows us to infer, from a set of candidate models, the model that is closest to the model that investors use in making their capital allocation decisions. Using our method, we assess the performance of the most commonly used asset pricing models in the literature.
Book Synopsis Empirical Asset Pricing by : Wayne Ferson
Download or read book Empirical Asset Pricing written by Wayne Ferson and published by MIT Press. This book was released on 2019-03-12 with total page 497 pages. Available in PDF, EPUB and Kindle. Book excerpt: An introduction to the theory and methods of empirical asset pricing, integrating classical foundations with recent developments. This book offers a comprehensive advanced introduction to asset pricing, the study of models for the prices and returns of various securities. The focus is empirical, emphasizing how the models relate to the data. The book offers a uniquely integrated treatment, combining classical foundations with more recent developments in the literature and relating some of the material to applications in investment management. It covers the theory of empirical asset pricing, the main empirical methods, and a range of applied topics. The book introduces the theory of empirical asset pricing through three main paradigms: mean variance analysis, stochastic discount factors, and beta pricing models. It describes empirical methods, beginning with the generalized method of moments (GMM) and viewing other methods as special cases of GMM; offers a comprehensive review of fund performance evaluation; and presents selected applied topics, including a substantial chapter on predictability in asset markets that covers predicting the level of returns, volatility and higher moments, and predicting cross-sectional differences in returns. Other chapters cover production-based asset pricing, long-run risk models, the Campbell-Shiller approximation, the debate on covariance versus characteristics, and the relation of volatility to the cross-section of stock returns. An extensive reference section captures the current state of the field. The book is intended for use by graduate students in finance and economics; it can also serve as a reference for professionals.
Book Synopsis Assessing Asset Pricing Models Using Revealed Preference by : Jonathan B. Berk
Download or read book Assessing Asset Pricing Models Using Revealed Preference written by Jonathan B. Berk and published by . This book was released on 2013 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: We propose a new method of testing asset pricing models that does not rely on prices and returns but on quantities (flows) instead. Under the assumption that capital markets are competitive and investors rational, an asset pricing model can only be correct if investors are using it in their capital allocation decisions. Therefore, any investment opportunity that the model identifies as having a non-zero alpha must be accompanied by capital flows of the same sign as the alpha. We use the data on active mutual funds to identify such flows, and find that the recent alternatives to the Capital Asset Pricing Model do not improve upon the original model.
Book Synopsis An Analytical Framework for Assessing Asset Pricing Models and Predictability by : René Garcia
Download or read book An Analytical Framework for Assessing Asset Pricing Models and Predictability written by René Garcia and published by . This book was released on 2008 with total page 47 pages. Available in PDF, EPUB and Kindle. Book excerpt: New insights about the connections between stock market volatility and returns, the pricing of long-run claims, or return predictability have recently revived interest in consumption-based equilibrium asset pricing. The recursive utility model is prominently used in these contexts to determine the price of assets in equilibrium. Often, solutions are approximate and quantities of interest are computed through simulations. We propose an approach that delivers closed-form formulas for price-consumption and price-dividend ratios, as well as for many of the statistics usually computed to assess the ability of the model to reproduce stylized facts. The proposed framework is flexible enough to capture rich dynamics for consumption and dividends. Closed-form formulas facilitate the economic interpretation of empirical results. We illustrate the usefulness of our approach by investigating the properties of long-run asset pricing models in many empirical dimensions.
Book Synopsis Market Proxies as Factors in Linear Asset Pricing Models by : Todd Prono
Download or read book Market Proxies as Factors in Linear Asset Pricing Models written by Todd Prono and published by . This book was released on 2015 with total page 39 pages. Available in PDF, EPUB and Kindle. Book excerpt: A new model misspecification measure for linear asset pricing models is proposed for the case where misspecification maps to latency of one of the pricing factors; in this case, the market return. This measure is suited both for testing models that include the market return as a pricing factor in a traditional sense (i.e., whether the chosen model does or does not price a collection of risky assets) and ranking those models (i.e., determining which model performs best). The proposed measure is used in pricing portfolios reflecting the size, value, and momentum premia. The conditional CAPM of Jagannathan and Wang (1996) is found to best the performance of both the simple CAPM and the ICAPM of Petkova (2006). Moreover, it is discovered that winner stocks in a momentum portfolio may have higher market betas than loser stocks.
Book Synopsis Essays on Market Frictions and Model Misspecification in Asset Pricing by : Norman Seeger
Download or read book Essays on Market Frictions and Model Misspecification in Asset Pricing written by Norman Seeger and published by . This book was released on 2009 with total page 157 pages. Available in PDF, EPUB and Kindle. Book excerpt:
Book Synopsis Assessing Asset Pricing Anomalies by : Michael J. Brennan
Download or read book Assessing Asset Pricing Anomalies written by Michael J. Brennan and published by . This book was released on 2008 with total page 66 pages. Available in PDF, EPUB and Kindle. Book excerpt: The optimal portfolio strategy is developed for an investor who has detected an asset pricing anomaly but is not certain that the anomaly is genuine rather than merely apparent. The analysis takes account of the fact that the parameters of both the underlying asset pricing model and the anomalous returns are estimated rather than known. The value that an investor would place on the ability to invest to exploit the apparent anomaly is also derived and illustrative calculations are presented for the Fama-French SMB and HML portfolios, whose returns are anomalous relative to the CAPM.
Book Synopsis Specification Tests of Asset Pricing Models Using Excess Returns by : Cesare Robotti
Download or read book Specification Tests of Asset Pricing Models Using Excess Returns written by Cesare Robotti and published by . This book was released on 2014 with total page 47 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this paper, we discuss the impact of different formulations of asset pricing models on the outcome of specification tests that are performed using excess returns. We point out that the popular way of specifying the stochastic discount factor (SDF) as a linear function of the factors is problematic because (1) the specification test statistic is not invariant to an affine transformation of the factors, and (2) the SDFs of competing models can have very different means. In contrast, an alternative specification that defines the SDF as a linear function of the de-meaned factors is free from these two problems and is more appropriate for model comparison. In addition, we suggest that a modification of the traditional Hansen-Jagannathan distance (HJ-distance) is needed when we use the de-meaned factors. The modified HJ-distance uses the inverse of the covariance matrix (instead of the second moment matrix) of excess returns as the weighting matrix to aggregate pricing errors. Asymptotic distributions of the modified HJ-distance and of the traditional HJ-distance based on the de-meaned SDF under the correctly specified model and the misspecified models are provided. Finally, we propose a simple methodology for computing the standard errors of the estimated SDF parameters that are robust to model misspecification. We show that failure to take model misspecification into account is likely to understate the standard errors of the estimates of the SDF parameters and lead us to erroneously conclude that certain factors are priced.
Book Synopsis Assessing Goodness-of-Fit of Asset Pricing Models by : F. Douglas Foster
Download or read book Assessing Goodness-of-Fit of Asset Pricing Models written by F. Douglas Foster and published by . This book was released on 2012 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: The development of asset pricing models that rely on instrumental variables together with the increased availability of easily-accessible economic time-series have renewed interest in predicting security returns. Evaluating the significance of these new research findings, however, is no easy task. Because these asset pricing theory tests are not independent, classical methods of assessing goodness-of-fit are inappropriate. This study investigates the distribution of the maximal R2 when k of m regressors are used to predict security returns. We provide a simple procedure that adjusts critical R2 values to account for selecting variables by searching among potential regressors.
Book Synopsis Assessing Asset Pricing Anomalies by : l J. Brennan
Download or read book Assessing Asset Pricing Anomalies written by l J. Brennan and published by . This book was released on 2010 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: The optimal portfolio strategy is developed for an investor who has detected an asset pricing anomaly but is not certain that the anomaly is genuine rather than merely apparent. The analysis takes account of the fact that the parameters of both the underlying asset pricing model and the anomalous returns are estimated rather than known. The value that an investor would place on the ability to invest to exploit the apparent anomaly is also derived and illustrative calculations are presented for the Fama and French SMB and HML portfolios, whose returns are anomalous relative to the CAPM.
Book Synopsis Evaluation of Linear Asset Pricing Models by Implied Portfolio Performance by : Ronald J. Balvers
Download or read book Evaluation of Linear Asset Pricing Models by Implied Portfolio Performance written by Ronald J. Balvers and published by . This book was released on 2006 with total page 46 pages. Available in PDF, EPUB and Kindle. Book excerpt: We adapt a metric of Kandel and Stambaugh (1995) to evaluate linear asset pricing models. The quot;KS-ratioquot; criterion rates a model's usefulness based on the mean portfolio return a mean-variance decision maker obtains for any variance choice by using the model for optimal portfolio decisions. It is equivalent to a cross-sectional GLS R-square criterion and to a measure of minimum distance between the asset and factor frontiers. We assess the KS-ratio compared to the HJ-distance and ad hoc goodness-of-fit evaluation criteria with simulated returns. We then apply the various criteria to evaluate nine prominent asset pricing models with actual data.
