Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology

101 Pages Posted: 22 Apr 2012 Last revised: 5 Jul 2014

See all articles by Raymond Kan

Raymond Kan

University of Toronto - Rotman School of Management

Cesare Robotti

Warwick Business School

Jay A. Shanken

Emory University - Goizueta Business School; National Bureau of Economic Research (NBER)

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Date Written: April 18, 2012

Abstract

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.

Suggested Citation

Kan, Raymond and Robotti, Cesare and Shanken, Jay A., Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology (April 18, 2012). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1361823 or http://dx.doi.org/10.2139/ssrn.1361823

Raymond Kan

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S3E6
Canada
416-978-4291 (Phone)
416-971-3048 (Fax)

Cesare Robotti

Warwick Business School ( email )

West Midlands, CV4 7AL
United Kingdom

Jay A. Shanken (Contact Author)

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States
404-727-4772 (Phone)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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