Evaluating the Specification Errors of Asset Pricing Models

55 Pages Posted: 16 May 2000 Last revised: 9 Jan 2002

See all articles by Robert J. Hodrick

Robert J. Hodrick

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Xiaoyan Zhang

Tsinghua University - PBC School of Finance

Date Written: April 2000

Abstract

This paper examines the specification errors of several asset pricing models using the methodology of Hansen and Jagannathan (1997) and a common data set. The models are the CAPM, the Consumption CAPM, the Jagannathan and Wang (1996) conditional CAPM, the Campbell (1996) dynamic asset pricing model, the Cochrane (1996) production-based model, and the Fama-French (1993) three-factor and five-factor models. We use returns on the Fama-French twenty-five portfolios sorted by size and book-to-market ratio and the risk-free rate as our test assets. The sample is 1952 to 1997. We allow the parameters of the models' pricing kernels to fluctuate with the business cycle which we measure in two ways. One uses the Hodrick-Prescott (1997) filter applied to either industrial production for monthly models or real GNP for quarterly models. The second approach for quarterly models uses the consumption-wealth measure developed by Lettau and Ludvigson (1999). While we cannot reject correct pricing for Campbell's model, a stability test indicates that the parameters may not be stable. None of the models correctly prices returns that are scaled by the term premium.

Suggested Citation

Hodrick, Robert J. and Zhang, Xiaoyan, Evaluating the Specification Errors of Asset Pricing Models (April 2000). NBER Working Paper No. w7661. Available at SSRN: https://ssrn.com/abstract=228135

Robert J. Hodrick (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

365 Fifth Avenue, 5th Floor
New York, NY 10016-4309
United States

Xiaoyan Zhang

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
58
Abstract Views
1,448
rank
375,814
PlumX Metrics