Model Comparison with Sharpe Ratios
51 Pages Posted: 4 Aug 2017 Last revised: 13 Mar 2019
Date Written: March 12, 2019
We show how to conduct asymptotically valid tests of model comparison when the extent of model mispricing is gauged by the squared Sharpe ratio improvement measure. This is equivalent to ranking models on their maximum Sharpe ratios, effectively extending the GRS test to accommodate comparison of non-nested models. Mimicking portfolios can be substituted for any nontraded model factors and estimation error in the portfolio weights is taken into account in the statistical inference. A variant of the Fama and French (2018) six-factor model, with a monthly-updated version of the usual value spread, emerges as the dominant model.
JEL Classification: G12, C12, C13
Suggested Citation: Suggested Citation