Minimum-Variance Kernels, Economic Risk Premia, and Tests of Multi-Beta Models

45 Pages Posted: 26 Jan 2015

See all articles by Pierluigi Balduzzi

Pierluigi Balduzzi

Boston College - Carroll School of Management

Cesare Robotti

Imperial College Business School

Date Written: November 2001

Abstract

This paper uses minimum-variance (MV) admissible kernels to estimate risk premia associated with economic risk variables and to test multi-beta models. Estimating risk premia using MV kernels is appealing because it avoids the need to 1) identify all relevant sources of risk and 2) assume a linear factor model for asset returns. Testing multi-beta models in terms of restricted MV kernels has the advantage that 1) the candidate kernel has the smallest volatility and 2) test statistics are easy to interpret in terms of Sharpe ratios. The authors find that several economic variables command significant risk premia and that the signs of the premia mostly correspond to the effect that these variables have on the risk-return trade-off, consistent with the implications of the intertemporal capital asset pricing model (I-CAPM). They also find that the MV kernel implied by the I-CAPM, while formally rejected by the data, consistently outperforms a pricing kernel based on the size and book-to-market factors of Fama and French (1993).

Keywords: minimum-variance kernels, intertemporal capital asset pricing model, economic risk premia

JEL Classification: G12

Suggested Citation

Balduzzi, Pierluigi and Robotti, Cesare, Minimum-Variance Kernels, Economic Risk Premia, and Tests of Multi-Beta Models (November 2001). FRB Atlanta Working Paper Series No. 2001-24, Available at SSRN: https://ssrn.com/abstract=2491105 or http://dx.doi.org/10.2139/ssrn.2491105

Pierluigi Balduzzi

Boston College - Carroll School of Management ( email )

Department of Finance
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Chestnut Hill, MA 02467
United States
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HOME PAGE: http://www.bc.edu/bc_org/avp/csom/faculty/

Cesare Robotti (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
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London SW7 2AZ, SW7 2AZ
United Kingdom

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