Premium
Assessing Specification Errors in Stochastic Discount Factor Models
Author(s) -
HANSEN LARS PETER,
JAGANNATHAN RAVI
Publication year - 1997
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1997.tb04813.x
Subject(s) - stochastic discount factor , econometrics , capital asset pricing model , discounting , economics , factor analysis , asset (computer security) , exploit , arbitrage , arbitrage pricing theory , derivative (finance) , computer science , financial economics , finance , computer security
In this article 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 onχ 2statistics 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.