Assessing Specification Errors in Stochastic Discount Factor Models

JOURNAL OF FINANCE, Vol 52 No 2, June 1997

Posted: 10 Mar 1997

See all articles by Lars Peter Hansen

Lars Peter Hansen

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Ravi Jagannathan

Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF); Indian School of Business (ISB), Hyderabad

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Abstract

In this paper we develop alternative ways to compare asset pricing models when it is understood that their implied stochastic discount factors do not price all portfolios correctly. Unlike comparisons based on 2 statistics associated with null hypotheses that models are correct, our measures of model performance do not reward variability of discount factor proxies. One of our measures is designed to exploit fully the implications of arbitrage-free pricing of derivative claims. We demonstrate empirically the usefulness of our methods in assessing some alternative stochastic factor models that have been proposed in asset pricing literature.

JEL Classification: E31

Suggested Citation

Hansen, Lars Peter and Jagannathan, Ravi, Assessing Specification Errors in Stochastic Discount Factor Models. JOURNAL OF FINANCE, Vol 52 No 2, June 1997. Available at SSRN: https://ssrn.com/abstract=3783

Lars Peter Hansen (Contact Author)

University of Chicago - Department of Economics ( email )

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Ravi Jagannathan

Northwestern University - Kellogg School of Management ( email )

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National Bureau of Economic Research (NBER)

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United States

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
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Shanghai, 200030
China

Indian School of Business (ISB), Hyderabad ( email )

Hyderabad, Gachibowli 500 019
India

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