On Robust Inference for Consumption-based Asset Pricing

65 Pages Posted: 30 Apr 2020 Last revised: 6 Jan 2021

See all articles by Tim Alexander Kroencke

Tim Alexander Kroencke

University of Neuchatel - Institute of Financial Analysis

Date Written: January 6, 2021

Abstract

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

Kroencke, Tim Alexander, On Robust Inference for Consumption-based Asset Pricing (January 6, 2021). Available at SSRN: https://ssrn.com/abstract=3562169 or http://dx.doi.org/10.2139/ssrn.3562169

Tim Alexander Kroencke (Contact Author)

University of Neuchatel - Institute of Financial Analysis ( email )

Pierre-a-Mazel,7
Neuchatel, CH-2000
Switzerland

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