Assessing Misspecifications in Asset Pricing Models with Nonlinear Projections of Pricing Kernels

49 Pages Posted: 15 Mar 2011

See all articles by Caio Almeida

Caio Almeida

Getulio Vargas Foundation ; Princeton University

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques; University of Montreal

Multiple version iconThere are 2 versions of this paper

Date Written: March 14, 2011

Abstract

We develop a new approach to identify model misspecifications based on Minimum Discrepancy (MD) projections that correct asset pricing models with the use of nonlinear functions of basis assets returns. These nonlinear corrections make our method more effective than the Hansen and Jagannathan distance in detecting sources of model specifications, especially in economies where nonlinear risk is priced. A theoretical example illustrates our point, with an economy where the true SDF prices coskewness risk with respect to the market portfolio (Kraus and Litzemberger (1976)). We suggest diagnosing the CAPM model under this economy, and show that while the HJ distance can not identify the exact source of model misspecification (a quadratic term in the market return), there are nonlinear projections in the class of MD problems that correctly capture this term. We also derive the asymptotic distributions of the estimators for the Cressie Read family of discrepancies, and illustrate their use with an empirical assessment of the CCAPM.

Keywords: Asset Pricing Proxies, Euler Equations, Minimum Discrepancy Estimators, Model Selection

JEL Classification: C1, C5, G1

Suggested Citation

Almeida, Caio and Garcia, René, Assessing Misspecifications in Asset Pricing Models with Nonlinear Projections of Pricing Kernels (March 14, 2011). Available at SSRN: https://ssrn.com/abstract=1785404 or http://dx.doi.org/10.2139/ssrn.1785404

Caio Almeida (Contact Author)

Getulio Vargas Foundation ( email )

Praia de Botafogo 190, 11o andar
Botafogo
Rio de Janeiro, Rio de Janeiro 22250-900
Brazil
5521-37995827 (Phone)
5521-2553-8821 (Fax)

HOME PAGE: http://www.fgv.br/professor/calmeida/

Princeton University ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
Canada
514-985-4014 (Phone)

University of Montreal ( email )

United States

Register to save articles to
your library

Register

Paper statistics

Downloads
48
Abstract Views
470
PlumX Metrics