On Robust Inference for Consumption-based Asset Pricing
65 Pages Posted: 30 Apr 2020 Last revised: 6 Jan 2021
Date Written: January 6, 2021
Kleibergen and Zhan (Robust Inference for Consumption-based Asset Pricing, Journal of Finance, 2020) propose a new approach to testing consumption-based asset pricing models that is robust to useless factors, i.e. factors uncorrelated with the test assets. They find that recently proposed factors do not pass their test. I provide extensive simulation experiments of empirically relevant cases, which show that their method has almost no power to detect useful factors with a significant return correlation of 0.45+. In contrast, the traditional Fama-MacBeth method comes with good size and considerably higher power in small samples. Bootstrap methods can be utilized to evaluate accuracy in larger samples. I argue that the problem of useless factors is hugely exaggerated to motivate a new “robust” methodology that is actually not more “robust” than traditional methods but comes at the cost of lacking power to detect useful factors in empirically relevant cases.
Keywords: Consumption-based asset pricing, useless factor problem, Fama-MacBeth regressions
JEL Classification: G12
Suggested Citation: Suggested Citation