Paper #1229

Title:

A unifying approach to the empirical evaluation of asset pricing models

Authors:

Francisco Peñaranda and Enrique Sentana

Date:

July 2010

Abstract:

Two main approaches are commonly used to empirically evaluate linear factor pricing models: regression and SDF methods, with centred and uncentred versions of the latter. We show that unlike standard two-step or iterated GMM procedures, single-step estimators such as continuously updated GMM yield numerically identical values for prices of risk, pricing errors, Jensen�s alphas and overidentifying restrictions tests irrespective of the model validity. Therefore, there is arguably a single approach regardless of the factors being traded or not, or the use of excess or gross returns. We illustrate our results by revisiting Lustig and Verdelhan�s (2007) empirical analysis of currency returns.

Keywords:

CU-GMM, Factor pricing models, Forward premium puzzle, Generalised Empirical Likelihood, Stochastic discount factor.

JEL codes:

G11, G12, C12, C13.

Area of Research:

Finance and Accounting / Statistics, Econometrics and Quantitative Methods

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