Empirical Tests of Asset Pricing Models with Individual Assets: Resolving the Errors-in-Variables Bias in Risk Premium Estimation

86 Pages Posted: 11 Jan 2017 Last revised: 6 Aug 2018

See all articles by Narasimhan Jegadeesh

Narasimhan Jegadeesh

Emory University - Department of Finance

Joonki Noh

Case Western Reserve University - Department of Banking and Finance

Kuntara Pukthuanthong

University of Missouri, Columbia

Richard Roll

California Institute of Technology

Junbo L. Wang

Louisiana State University, Baton Rouge

Multiple version iconThere are 2 versions of this paper

Date Written: May 20, 2018

Abstract

To attenuate an inherent errors-in-variables bias, portfolios are widely employed to test asset pricing models; but portfolios might mask relevant risk- or return-related features of individual assets. We propose an instrumental variables approach that allows the use of individual stocks as test assets, yet delivers consistent estimates of ex-post risk premiums. This estimator also yields well-specified tests in small samples. The market risk premium under the CAPM and the liquidity-adjusted CAPM, premiums on risk factors under the Fama-French three- and five-factors models and the Hou, Xue, and Zhang (2015) four-factor model are all insignificant after controlling for asset characteristics.

Keywords: Risk Premium Estimation, Errors-in-Variables Bias, Instrumental Variables, Individual Stocks, Asset Pricing Models

Suggested Citation

Jegadeesh, Narasimhan and Noh, Joonki and Pukthuanthong, Kuntara and Roll, Richard W. and Wang, Junbo L., Empirical Tests of Asset Pricing Models with Individual Assets: Resolving the Errors-in-Variables Bias in Risk Premium Estimation (May 20, 2018). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2897821 or http://dx.doi.org/10.2139/ssrn.2897821

Narasimhan Jegadeesh (Contact Author)

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States

Joonki Noh

Case Western Reserve University - Department of Banking and Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-3737 (Phone)

Kuntara Pukthuanthong

University of Missouri, Columbia ( email )

Robert J. Trulaske, Sr. College of Business
403 Cornell Hall
Columbia, MO 65211
United States
6198076124 (Phone)

HOME PAGE: http://https://kuntara.weebly.com

Richard W. Roll

California Institute of Technology ( email )

1200 East California Blvd
Mail Code: 228-77
Pasadena, CA 91125
United States
626-395-3890 (Phone)
310-836-3532 (Fax)

Junbo L. Wang

Louisiana State University, Baton Rouge ( email )

Baton Rouge, LA 70803
United States

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