The efficiency of the SDF and Beta methods at evaluating multi-factor asset-pricing models

Martín Carlos Lozano Banda, Stuart Hyde, Ian Garrett

Research output: Contribution to conferencePaper

Abstract

The classical beta method and the stochastic discount factor (SDF) method may be
considered competing paradigms for empirical work in asset pricing. The two methods are equally efficient at estimating risk premiums in the context of the single-factor model. We show this does not hold for multi-factor models. Inference is consistently more reliable in the Beta method for the estimates in models which include size, value and momentum factors. However, our evidence also illustrates that the SDF method is generally more efficient at estimating sample pricing errors. Finally, the specification test in the Beta method tends to under-reject in finite samples while the SDF method has approximately the correct size. Our Monte Carlo simulation results are consistent whether we use a normal or empirical distribution, or different sets and sizes of tests portfolios.
Original languageEnglish
Publication statusPublished - 1 Jan 2009
EventSouthwestern Finance Association : 48th Annual Meeting Proceedings - Oklahoma City, United States
Duration: 1 Jan 20098 Jan 2009
Conference number: 48th Annual Meeting

Conference

ConferenceSouthwestern Finance Association
Abbreviated titleSWFA
CountryUnited States
CityOklahoma City
Period1/1/098/1/09

Fingerprint

Stochastic discount factor
Multifactor asset pricing model
Monte Carlo simulation
Factors
Empirical distribution
Pricing errors
Paradigm
Specification test
Inference
Normal distribution
Multifactor model
Asset pricing
Momentum
Finite sample
Risk premium

Cite this

Lozano Banda, M. C., Hyde, S., & Garrett, I. (2009). The efficiency of the SDF and Beta methods at evaluating multi-factor asset-pricing models. Paper presented at Southwestern Finance Association , Oklahoma City, United States.
Lozano Banda, Martín Carlos ; Hyde, Stuart ; Garrett, Ian. / The efficiency of the SDF and Beta methods at evaluating multi-factor asset-pricing models. Paper presented at Southwestern Finance Association , Oklahoma City, United States.
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Lozano Banda, MC, Hyde, S & Garrett, I 2009, 'The efficiency of the SDF and Beta methods at evaluating multi-factor asset-pricing models' Paper presented at Southwestern Finance Association , Oklahoma City, United States, 1/1/09 - 8/1/09, .

The efficiency of the SDF and Beta methods at evaluating multi-factor asset-pricing models. / Lozano Banda, Martín Carlos; Hyde, Stuart; Garrett, Ian.

2009. Paper presented at Southwestern Finance Association , Oklahoma City, United States.

Research output: Contribution to conferencePaper

TY - CONF

T1 - The efficiency of the SDF and Beta methods at evaluating multi-factor asset-pricing models

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AU - Hyde, Stuart

AU - Garrett, Ian

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N2 - The classical beta method and the stochastic discount factor (SDF) method may beconsidered competing paradigms for empirical work in asset pricing. The two methods are equally efficient at estimating risk premiums in the context of the single-factor model. We show this does not hold for multi-factor models. Inference is consistently more reliable in the Beta method for the estimates in models which include size, value and momentum factors. However, our evidence also illustrates that the SDF method is generally more efficient at estimating sample pricing errors. Finally, the specification test in the Beta method tends to under-reject in finite samples while the SDF method has approximately the correct size. Our Monte Carlo simulation results are consistent whether we use a normal or empirical distribution, or different sets and sizes of tests portfolios.

AB - The classical beta method and the stochastic discount factor (SDF) method may beconsidered competing paradigms for empirical work in asset pricing. The two methods are equally efficient at estimating risk premiums in the context of the single-factor model. We show this does not hold for multi-factor models. Inference is consistently more reliable in the Beta method for the estimates in models which include size, value and momentum factors. However, our evidence also illustrates that the SDF method is generally more efficient at estimating sample pricing errors. Finally, the specification test in the Beta method tends to under-reject in finite samples while the SDF method has approximately the correct size. Our Monte Carlo simulation results are consistent whether we use a normal or empirical distribution, or different sets and sizes of tests portfolios.

M3 - Paper

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Lozano Banda MC, Hyde S, Garrett I. The efficiency of the SDF and Beta methods at evaluating multi-factor asset-pricing models. 2009. Paper presented at Southwestern Finance Association , Oklahoma City, United States.