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Pricing Model Performance and the Two‐Pass Cross‐Sectional Regression Methodology

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  • RAYMOND KAN
  • CESARE ROBOTTI
  • JAY SHANKEN

Abstract

Over the years, many asset pricing studies have employed the sample cross‐sectional regression (CSR) R2 as a measure of model performance. We derive the asymptotic distribution of this statistic and develop associated model comparison tests, taking into account the impact of model misspecification on the variability of the CSR estimates. We encounter several examples of large R2 differences that are not statistically significant. A version of the intertemporal capital asset pricing model (CAPM) exhibits the best overall performance, followed by the Fama–French three‐factor model. Interestingly, the performance of prominent consumption CAPMs is sensitive to variations in experimental design.

Suggested Citation

  • Raymond Kan & Cesare Robotti & Jay Shanken, 2013. "Pricing Model Performance and the Two‐Pass Cross‐Sectional Regression Methodology," Journal of Finance, American Finance Association, vol. 68(6), pages 2617-2649, December.
    • Handle: RePEc:bla:jfinan:v:68:y:2013:i:6:p:2617-2649
    DOI: 10.1111/jofi.12035
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    More about this item

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C4 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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