NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Assessing Specification Errors in Stochastic Discount Factor Models

Lars Peter Hansen, Ravi Jagannathan

NBER Technical Working Paper No. 153
Issued in February 1994
NBER Program(s):   AP

In this paper 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 on x2 statistics associated with null hypothesis 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 methods in assessing some alternative stochastic factor models that have been proposed in asset pricing literature.

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Document Object Identifier (DOI): 10.3386/t0153

Published: Journal of Finance, Vol. 52, no. 2 (June 1997): 557-590.

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