Robust Inference in Linear Asset Pricing Models

90 Pages Posted: 23 Nov 2012 Last revised: 7 Jun 2016

See all articles by Nikolay Gospodinov

Nikolay Gospodinov

Federal Reserve Bank of Atlanta

Raymond Kan

University of Toronto - Rotman School of Management

Cesare Robotti

Warwick Business School

Date Written: March 21, 2013

Abstract

Many asset pricing models include risk factors that are only weakly correlated with the asset returns. We show that in the presence of a factor that is independent of the returns ("useless factor"), the standard inference procedures for evaluating its pricing ability could be highly misleading in misspecified models. Our proposed model selection procedure, which is robust to useless factors and potential model misspecification, restores the standard inference and proves to be effective in eliminating factors that do not improve the model's pricing ability. The practical relevance of our analysis is illustrated using simulations and an empirical application.

Keywords: Asset Pricing Models, Model Misspecification, Weak Identification, Useless Factor

JEL Classification: G12, C13, C32

Suggested Citation

Gospodinov, Nikolay and Kan, Raymond and Robotti, Cesare, Robust Inference in Linear Asset Pricing Models (March 21, 2013). Rotman School of Management Working Paper No. 2179620. Available at SSRN: https://ssrn.com/abstract=2179620 or http://dx.doi.org/10.2139/ssrn.2179620

Nikolay Gospodinov

Federal Reserve Bank of Atlanta ( email )

Atlanta, GA 30309
United States

HOME PAGE: https://www.frbatlanta.org/research/economists/gospodinov-nikolay.aspx?panel=1

Raymond Kan

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-978-4291 (Phone)
416-971-3048 (Fax)

Cesare Robotti (Contact Author)

Warwick Business School ( email )

West Midlands, CV4 7AL
United Kingdom

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