Abstract

http://ssrn.com/abstract=2326753
 


 



Measuring the 'Dark Matter' in Asset Pricing Models


Hui Chen


Massachusetts Institute of Technology; National Bureau of Economic Research (NBER)

Winston Wei Dou


Massachusetts Institute of Technology (MIT) - Sloan School of Management

Leonid Kogan


Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

September 17, 2013


Abstract:     
Models of rational expectations endow agents with precise knowledge of the probability laws inside the models. This assumption becomes more tenuous when a model's performance is highly sensitive to the parameters that are difficult to estimate directly, i.e., when a model relies on "dark matter." We propose new measures of model fragility by quantifying the informational burden that a rational expectations model places on the agents. By measuring the informativeness of the cross-equation restrictions implied by a model, our measures can systematically detect the direction in the parameter space in which the model's performance is the most fragile. Our methodology provides new ways to conduct sensitivity analysis on quantitative models. It helps identify situations where parameter or model uncertainty cannot be ignored. It also helps with evaluating competing classes of models that try to explain the same set of empirical phenomena from the perspective of the robustness of their implications.

Number of Pages in PDF File: 64

Keywords: model fragility, robustness, rational expectation, cross-equation restriction, information theory

JEL Classification: C1, D83, E44, G12

working papers series


Download This Paper

Date posted: September 19, 2013  

Suggested Citation

Chen, Hui and Dou, Winston Wei and Kogan, Leonid, Measuring the 'Dark Matter' in Asset Pricing Models (September 17, 2013). Available at SSRN: http://ssrn.com/abstract=2326753 or http://dx.doi.org/10.2139/ssrn.2326753

Contact Information

Hui Chen (Contact Author)
Massachusetts Institute of Technology ( email )
50 Memorial Drive
Cambridge, MA 02142
United States
617-324-3896 (Phone)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Winston Wei Dou
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
E62-416
Cambridge, MA
United States
Leonid Kogan
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
50 Memorial Drive
Cambridge, MA 02142
United States
617-253-2289 (Phone)
617-258-6855 (Fax)
HOME PAGE: http://web.mit.edu/lkogan2/www/
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Feedback to SSRN


Paper statistics
Abstract Views: 798
Downloads: 166
Download Rank: 103,460

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo3 in 0.766 seconds