Macro-Finance Decoupling: Robust Evaluations of Macro Asset Pricing Models

31 Pages Posted: 26 May 2020 Last revised: 17 Feb 2021

See all articles by Xu Cheng

Xu Cheng

University of Pennsylvania - Department of Economics

Winston Dou

The Wharton School, University of Pennsylvania

Zhipeng Liao

University of California, Los Angeles (UCLA) - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: February 16, 2021

Abstract

This paper shows that robust inference under weak identification is important to the evaluation of many influential macro asset pricing models, including long-run risk models and (time-varying) rare-disaster risk models. Building on recent developments in the conditional inference literature, we provide a novel conditional specification test by simulating the critical value conditional on a sufficient statistic. This sufficient statistic can be intuitively interpreted as a measure capturing the macroeconomic information decoupled from the underlying content of asset pricing theories. Macro-finance decoupling is an effective way to improve the power of the specification test when asset pricing theories are difficult to refute because of a severe imbalance in the information content about the key model parameters between macroeconomic moment restrictions and asset pricing cross-equation restrictions. For empirical application, we apply the proposed conditional specification test to evaluate a time-varying rare-disaster risk model and construct data-driven robust model uncertainty sets.

The supplemental appendix can be found at: https://ssrn.com/abstract=3609598.
The additional materials can be found at: https://ssrn.com/abstract=3787125.

Keywords: Structural asset pricing, Conditional inference, Rare disasters, Long-run risk, Weak identification, Model uncertainty.

JEL Classification: C12, C32, C52, G12

Suggested Citation

Cheng, Xu and Dou, Winston and Liao, Zhipeng, Macro-Finance Decoupling: Robust Evaluations of Macro Asset Pricing Models (February 16, 2021). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3609627 or http://dx.doi.org/10.2139/ssrn.3609627

Xu Cheng (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

HOME PAGE: http://www.sas.upenn.edu/~xucheng/

Winston Dou

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

Zhipeng Liao

University of California, Los Angeles (UCLA) - Department of Economics ( email )

8283 Bunche Hall
Los Angeles, CA 90095-1477
United States

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