Robust Inference for Consumption-based Asset Pricing with Power
60 Pages Posted: 30 Apr 2020 Last revised: 21 Nov 2022
Date Written: October 14, 2022
Kleibergen and Zhan (2020) propose a new approach to test consumption-based asset pricing models that is robust to the “useless” factor problem, i.e., concluding too often that a factor is priced when the factor is actually uncorrelated with the test assets and is not priced. I show that even when factor correlation is economically large and significant (think of 0.40 and larger), their testing approach lacks power in small samples to detect sufficient factor correlation or to find that a factor is priced. I propose simple remedies that help to achieve robust and powerful asset pricing tests.
Keywords: Consumption-based asset pricing, useless factor problem, Fama-MacBeth regressions
JEL Classification: G12
Suggested Citation: Suggested Citation