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A Skeptical Appraisal of Asset Pricing TestsJonathan LewellenDartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER) Stefan NagelStanford Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research Jay A. ShankenEmory University - Goizueta Business School; National Bureau of Economic Research (NBER) May 1, 2008 AFA 2007 Chicago Meetings Paper EFA 2006 Zurich Meetings Paper Abstract: It has become standard practice in the cross-sectional asset-pricing literature to evaluate models based on how well they explain average returns on size-B/M portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that asset-pricing tests are often highly misleading, in the sense that apparently strong explanatory power (high cross-sectional R2s and small pricing errors) in fact provides quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models don't work as well as originally advertised.
Number of Pages in PDF File: 44 Keywords: asset pricing tests, stock returns, cross section working papers seriesDate posted: March 17, 2006 ; Last revised: February 24, 2009Suggested CitationContact Information
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