Empirical Evaluation of Asset Pricing Models: Arbitrage and Pricing Errors in Contingent Claims

39 Pages Posted: 18 Mar 2008 Last revised: 14 May 2014

See all articles by Zhenyu Wang

Zhenyu Wang

Indiana University, Kelley School of Business

Xiaoyan Zhang

Tsinghua University - PBC School of Finance

Date Written: November 1, 2011

Abstract

Hansen and Jagannathan (1997) have developed two measures of pricing errors for asset-pricing models: the maximum pricing error in all static portfolios of the test assets and the maximum pricing error in all contingent claims of the assets. In this paper, we develop simulation-based Bayesian inference for these measures. While the literature reports that the time-varying extensions substantially reduce pricing errors of classic models on the standard test assets, our analysis shows that the reduction is much smaller based on the second measure. Those time-varying models have large pricing errors on the contingent claims of the test assets because their stochastic dis- count factors are often negative and admit arbitrage opportunities.

Keywords: asset pricing, arbitrage, contingent claims

JEL Classification: G1, G12

Suggested Citation

Wang, Zhenyu and Zhang, Xiaoyan, Empirical Evaluation of Asset Pricing Models: Arbitrage and Pricing Errors in Contingent Claims (November 1, 2011). FRB of New York Staff Report No. 265, Available at SSRN: https://ssrn.com/abstract=941701 or http://dx.doi.org/10.2139/ssrn.941701

Zhenyu Wang (Contact Author)

Indiana University, Kelley School of Business ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://www.kelley.iu.edu/Finance/Faculty/page12594.cfm?ID=37555

Xiaoyan Zhang

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

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