Arbitrage, Good Deals and Stochastic Discount Factor Restrictions on Multi-Factor Models With Coskewness
Dublin City University Business School; Catholic University S.C. Piacenza
March 3, 2007
This paper employs a stochastic discount factor (SDF) volatility upper bound to limit the attainable maximal Sharpe ratio and thus, together with a no arbitrage condition, to rule out "good deals". While no-arbitrage and the SDF volatility bound imply relatively weak assumptions about investors' preferences and do not require the specification of a full-blown asset pricing theory, they do provide useful restrictions on factor model estimates. This is shown by imposing these restrictions in the estimation of various multifactor models that allow for a non-zero price of coskewness risk. Empirically, while coskewness explains cross-sectional variation in average excess returns not explained by the Fama and French (1996) factors, its price is of a much more modest magnitude than in unrestricted estimates.
Number of Pages in PDF File: 51
Keywords: Asset Pricing, Coskewness, Linear Pricing, Maximal Sharpe Ratios
JEL Classification: G12working papers series
Date posted: March 4, 2007
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