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Evaluating asset pricing models with non-traded factors using the method of maximum-correlated portfolios

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  • Yang, Ge
  • Yin, Ximing
  • Kimmel, Robert L.

Abstract

This paper examines the performance of several important asset pricing models with non-traded factors. We propose to test the asset pricing models using the method of Maximum-Correlated (MC) Portfolios. This method is particularly useful when evaluating models with non-traded factors, where the models are potentially mis-specified and factors are possibly noisy. The Q-statistics and Sharpe ratios, derived from MC portfolio method, are used as the goodness-of-fit measures. Smaller Q-stats and higher Sharpe ratios indicate better model performance. We find that Campbell (1996) and Jagannathan and Wang (1996) models are among the best models to price the test assets. These results differ significantly from the existing methods which may be biased by noisy factors.

Suggested Citation

  • Yang, Ge & Yin, Ximing & Kimmel, Robert L., 2023. "Evaluating asset pricing models with non-traded factors using the method of maximum-correlated portfolios," The North American Journal of Economics and Finance, Elsevier, vol. 68(C).
    • Handle: RePEc:eee:ecofin:v:68:y:2023:i:c:s1062940823001031
    DOI: 10.1016/j.najef.2023.101980
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    References listed on IDEAS

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    1. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
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    Cited by:

    1. Yin, Ximing & Yang, Ge, 2024. "Instantaneous volatility of the yield curve, variance risk premium and bond return predictability," Journal of Empirical Finance, Elsevier, vol. 77(C).

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    More about this item

    Keywords

    Maximum-correlated portfolios; Non-traded factor models; Sharpe ratios;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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