A Unifying Approach to the Empirical Evaluation of Asset Pricing Models

46 Pages Posted: 28 Jul 2010

See all articles by Francisco Penaranda

Francisco Penaranda

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI); Financial Markets Group; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: August 2010

Abstract

Two main approaches are commonly used to empirically evaluate linear factor pricing models: regression and SDF methods, with centred and uncentred versions of the latter. We show that unlike standard two-step or iterated GMM procedures, single-step estimators such as continuously updated GMM yield numerically identical values for prices of risk, pricing errors, Jensen's alphas and overidentifying restrictions tests irrespective of the model validity. Therefore, there is arguably a single approach regardless of the factors being traded or not, or the use of excess or gross returns. We illustrate our results by revisiting Lustig and Verdelhan's (2007) empirical analysis of currency returns.

Keywords: CU-GMM, Factor pricing models, Forward premium puzzle, Generalised Empirical Likelihood, Stochastic discount factor

JEL Classification: C12, C13, G11, G12

Suggested Citation

Penaranda, Francisco and Sentana, Enrique, A Unifying Approach to the Empirical Evaluation of Asset Pricing Models (August 2010). CEPR Discussion Paper No. DP7943. Available at SSRN: https://ssrn.com/abstract=1649891

Francisco Penaranda (Contact Author)

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~sentana/

Financial Markets Group

Houghton Street
London School of Economics & Political Science (LSE)
London WC2A 2AE
United Kingdom
+44 20 7955 7002 (Phone)
+44 20 7852 3580 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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