Conditioning Information and Variance Bounds on Pricing Kernels

41 Pages Posted: 8 Feb 1999 Last revised: 7 May 2000

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: January 1999

Abstract

We show how to use conditioning information optimally to construct a sharper unconditional Hansen-Jagannathan (1991) bound. The approach in this paper is different from that of Gallant, Hansen and Tauchen (1990), but both approaches yield the same bound when the conditional moments are known. Unlike Gallant, Hansen and Tauchen, our approach is robust to misspecification of the first and second conditional moments. Potential applications include testing dynamic asset pricing models, studying the predictability of asset returns, diagnosing the accuracy of competing models for the first and second conditional moments of asset returns, dynamic asset allocation and mutual fund performance measurement. The illustration in this article starts with the familiar Hansen-Singleton (1983) setup of an autoregressive model for consumption growth and bond and stock returns. Our innovation is to add time-varying volatility to the model. Both an unconstrained version and a version with the restrictions of the standard consumption-based asset pricing model imposed serve as the data-generating processes to illustrate the behavior of the bounds. In the process, we discover and explore an interesting empirical phenomenon: asymmetric volatility in consumption growth.

Suggested Citation

Bekaert, Geert and Liu, Jun, Conditioning Information and Variance Bounds on Pricing Kernels (January 1999). NBER Working Paper No. w6880. Available at SSRN: https://ssrn.com/abstract=146934

Geert Bekaert (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Jun Liu

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States
858.534.2022 (Phone)
5858.534.0745 (Fax)

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