A Unifying Approach to the Empirical Evaluation of Asset Pricing Models

Center for Financial Innovation and Stability Working Paper No. 10-03

53 Pages Posted: 4 Jan 2011

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: December 30, 2010

Abstract

Two main approaches are commonly used to empirically evaluate linear factor pricing models: regression and stochastic discount factor (SDF) methods, with centered and uncentered versions of the latter. We show that unlike standard two-step or iterated generalized method of moments (GMM) procedures, single-step estimators such as continuously updated GMMs 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 the use of excess or gross returns. We illustrate our results with the currency returns constructed by Lustig and Verdelhan (2007).

Keywords: CU-GMM, Factor Pricing Models, Forward Premium Puzzle, Generalized Empirical Likelihood, Stochastic Discount Factor

JEL Classification: , G12, C12, C13

Suggested Citation

Penaranda, Francisco and Sentana, Enrique, A Unifying Approach to the Empirical Evaluation of Asset Pricing Models (December 30, 2010). Center for Financial Innovation and Stability Working Paper No. 10-03. Available at SSRN: https://ssrn.com/abstract=1734391 or http://dx.doi.org/10.2139/ssrn.1734391

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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