Evaluating alternative methods for testing asset pricing models with historical data

Research output: Contribution to journalArticle

6 Citations (Scopus)

Abstract

We follow the correct Jagannathan and Wang (2002) framework for comparing the estimates and specification tests of the classical Beta and Stochastic Discount Factor/Generalized Method of Moments (SDF/GMM) methods. We extend previous studies by considering not only single but also multifactor models, and by taking into account some of the prescriptions for improving empirical tests suggested by Lewellen, Nagel and Shanken (2010). Our results reveal that SDF/GMM first-stage estimators lead to lower pricing errors than OLS, while SDF/GMM second stage estimators display higher pricing errors than the classical Beta GLS method. While Jagannathan and Wang (2002), and Cochrane (2005) conclude that there are no differences when estimating and testing by the Beta and SDF/GMM methods for the CAPM, we show that their conclusion cannot be extensible for multifactor models. Moreover, the Beta methods (OLS and GLS) seem to dominate the SDF/GMM (first and second stages) procedure in terms of estimators' properties. These results are consistent across benchmark portfolios and sample periods.
Original languageEnglish
Pages (from-to)136–146
JournalJournal of Empirical Finance
Volume18
Issue number1
DOIs
Publication statusPublished - Jan 2011

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Asset pricing models
Generalized method of moments
Stochastic discount factor
Testing
Estimator
Pricing errors
Multifactor model
Empirical test
Prescription
Specification test
Benchmark portfolio
Capital asset pricing model

Cite this

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title = "Evaluating alternative methods for testing asset pricing models with historical data",
abstract = "We follow the correct Jagannathan and Wang (2002) framework for comparing the estimates and specification tests of the classical Beta and Stochastic Discount Factor/Generalized Method of Moments (SDF/GMM) methods. We extend previous studies by considering not only single but also multifactor models, and by taking into account some of the prescriptions for improving empirical tests suggested by Lewellen, Nagel and Shanken (2010). Our results reveal that SDF/GMM first-stage estimators lead to lower pricing errors than OLS, while SDF/GMM second stage estimators display higher pricing errors than the classical Beta GLS method. While Jagannathan and Wang (2002), and Cochrane (2005) conclude that there are no differences when estimating and testing by the Beta and SDF/GMM methods for the CAPM, we show that their conclusion cannot be extensible for multifactor models. Moreover, the Beta methods (OLS and GLS) seem to dominate the SDF/GMM (first and second stages) procedure in terms of estimators' properties. These results are consistent across benchmark portfolios and sample periods.",
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Evaluating alternative methods for testing asset pricing models with historical data. / Lozano Banda, Martín Carlos; Rubio, Gonzalo.

In: Journal of Empirical Finance, Vol. 18, No. 1, 01.2011, p. 136–146.

Research output: Contribution to journalArticle

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