DP12085 Empirical Evaluation of Overspecified Asset Pricing Models

Author(s): Elena Manresa, Francisco PeƱaranda, Enrique Sentana
Publication Date: June 2017
Keyword(s): Continuously Updated GMM, Factor pricing models, Set estimation, Stochastic discount factor, Underidentification tests
JEL(s): C52, G12
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12085

Asset pricing models with potentially too many risk factors are increasingly common in empirical work. Unfortunately, they can yield misleading statistical inferences. Unlike other studies focusing on the properties of standard estimators and tests, we estimate the sets of SDFs and risk prices compatible with the asset pricing restrictions of a given model. We also propose tests to detect problematic situations with economically meaningless SDFs uncorrelated to the test assets. We confirm the empirical relevance of our proposed estimators and tests with Yogo's (2006) linearized version of the consumption CAPM, and provide Monte Carlo evidence on their reliability in finite samples.