Elephants and the Cross-Section of Expected Returns
37 Pages Posted: 21 Nov 2017 Last revised: 15 Mar 2019
Date Written: March 11, 2019
Standard GMM cross-sectional asset pricing tests are susceptible to a ``trade-off'': They can generate high explanatory power for factor models by allowing the estimated factor means to substantially deviate from the observed sample averages. In fact, by shifting the weights on the moment conditions, any level of cross-sectional fit can be attained. This property is a feature of the GMM estimation design and applies to weak as well as strong factors, and to all sample sizes and test assets. To quantify the trade-off, we run tests based on simulated and empirical data.
Keywords: Asset pricing, cross-section of expected returns, GMM, factor zoo
JEL Classification: G00, G12, C21, C13
Suggested Citation: Suggested Citation