Empirical Asset Pricing With Many Test Assets

55 Pages Posted: 28 Nov 2018 Last revised: 29 Dec 2023

See all articles by Rasmus Lönn

Rasmus Lönn

Erasmus University Rotterdam (EUR) - Department of Econometrics

Peter C. Schotman

Maastricht University - Department of Finance

Date Written: October 31, 2018

Abstract

We reformulate the problem of estimating risk prices in a stochastic discount factor model as an instrumental variables regression. The IV estimator allows efficient estimation for models with non-traded factors and many test assets. Optimal instruments are constructed using a regularised sparse first stage regression. In a simulation study the IV estimator is close to the infeasible GMM estimator in a setting with many assets. In an empirical application, the tracking portfolio for consumption growth appears strongly correlated with consumption news. It implies that consumption is a priced factor for the cross-section of excess equity returns. A similar regularised regression, projecting the stochastic discount factor on test assets, leads to an estimate of the Hansen-Jagannathan distance, and identifies portfolios that maximally violate the pricing implications of the model.

Keywords: Boosting, Asset Pricing Tests, Hansen-Jagannathan Distance

JEL Classification: G12, C44, C55

Suggested Citation

Lönn, Rasmus and Schotman, Peter C., Empirical Asset Pricing With Many Test Assets (October 31, 2018). Available at SSRN: https://ssrn.com/abstract=3278229 or http://dx.doi.org/10.2139/ssrn.3278229

Rasmus Lönn

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Peter C. Schotman (Contact Author)

Maastricht University - Department of Finance ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3862 (Phone)
+31 43 388 4875 (Fax)

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