Empirical Evaluation of Overspecified Asset Pricing Models

52 Pages Posted: 13 Jun 2017

See all articles by Elena Manresa

Elena Manresa

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Francisco Peñaranda

CUNY Queens College

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI); Financial Markets Group; Centre for Economic Policy Research (CEPR)

Date Written: June 2017

Abstract

Asset pricing models with potentially too many risk factors are increasingly common in empirical work. Unfortunately, they can yield misleading statistical inferences. Unlike other studies focusing on the properties of standard estimators and tests, we estimate the sets of SDFs and risk prices compatible with the asset pricing restrictions of a given model. We also propose tests to detect problematic situations with economically meaningless SDFs uncorrelated to the test assets. We confirm the empirical relevance of our proposed estimators and tests with Yogo's (2006) linearized version of the consumption CAPM, and provide Monte Carlo evidence on their reliability in finite samples.

Keywords: Continuously Updated GMM, Factor pricing models, Set estimation, Stochastic discount factor, Underidentification tests.

JEL Classification: C52, G12

Suggested Citation

Manresa, Elena and Peñaranda, Francisco and Sentana, Enrique, Empirical Evaluation of Overspecified Asset Pricing Models (June 2017). CEPR Discussion Paper No. DP12085. Available at SSRN: https://ssrn.com/abstract=2984781

Elena Manresa (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Ave. E62-663
Cambridge, MA 02142
United States

Francisco Peñaranda

CUNY Queens College ( email )

Flushing, NY 11367
United States

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~sentana/

Financial Markets Group

Houghton Street
London School of Economics & Political Science (LSE)
London WC2A 2AE
United Kingdom
+44 20 7955 7002 (Phone)
+44 20 7852 3580 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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