A Skeptical Appraisal of Asset Pricing Tests

44 Pages Posted: 17 Mar 2006 Last revised: 24 Feb 2009

See all articles by Jonathan Lewellen

Jonathan Lewellen

Dartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER)

Stefan Nagel

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research; CESifo (Center for Economic Studies and Ifo Institute)

Jay A. Shanken

Emory University - Goizueta Business School; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 1, 2008

Abstract

It has become standard practice in the cross-sectional asset-pricing literature to evaluate models based on how well they explain average returns on size-B/M portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that asset-pricing tests are often highly misleading, in the sense that apparently strong explanatory power (high cross-sectional R2s and small pricing errors) in fact provides quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models don't work as well as originally advertised.

Keywords: asset pricing tests, stock returns, cross section

Suggested Citation

Lewellen, Jonathan W. and Nagel, Stefan and Shanken, Jay A., A Skeptical Appraisal of Asset Pricing Tests (May 1, 2008). AFA 2007 Chicago Meetings Paper; EFA 2006 Zurich Meetings Paper. Available at SSRN: https://ssrn.com/abstract=891434 or http://dx.doi.org/10.2139/ssrn.891434

Jonathan W. Lewellen (Contact Author)

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States
603-646-8650 (Phone)

National Bureau of Economic Research (NBER)

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Stefan Nagel

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

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United States

Centre for Economic Policy Research ( email )

London
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CESifo (Center for Economic Studies and Ifo Institute) ( email )

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Germany

Jay A. Shanken

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States
404-727-4772 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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