Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology
University of Toronto - Rotman School of Management
Federal Reserve Bank of Atlanta; EDHEC Risk Institute
Jay A. Shanken
Emory University - Goizueta Business School; National Bureau of Economic Research (NBER)
April 18, 2012
Journal of Finance, Forthcoming
Over the years, many asset pricing studies have employed the sample cross-sectional regression (CSR) R2 as a measure of model performance. We derive the asymptotic distribution of this statistic and develop associated model comparison tests, taking into account the inevitable impact of model misspecification on the variability of the two-pass CSR estimates. We encounter several examples of large R2 differences that are not statistically significant. A version of the intertemporal CAPM exhibits the best overall performance, followed by the "three-factor model" of Fama and French (1993). Interestingly, the performance of prominent consumption CAPMs proves to be sensitive to variations in experimental design.
Number of Pages in PDF File: 101Accepted Paper Series
Date posted: April 22, 2012 ; Last revised: May 9, 2012
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