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Tradable or nontradable factors—what does the Hansen–Jagannathan distance tell us?

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  • Zhang, Xiang
  • Liu, Yangyi
  • Wu, Kun
  • Maillet, Bertrand

Abstract

We investigate the difference in pricing cross-sectional risky assets performance between tradable and nontradable factors by comparing their misspecification errors—the Hansen–Jagannathan (HJ) distance. By constructing nontradable factors mimicking portfolios (FMPs) and incorporating them into the least-misspecified tradable stochastic dis-count factor (SDF), we provide cross-country empirical evidence that this SDF that combines tradable and nontradable factors dominates others in which nontradable factors further decrease the SDF’s mis-specification errors. Since nontradable FMPs are functions of current tradable factor information about the economic state, FMPs “hedge” the state variable risks, and FMPs’ returns describe the risk premiums.

Suggested Citation

  • Zhang, Xiang & Liu, Yangyi & Wu, Kun & Maillet, Bertrand, 2021. "Tradable or nontradable factors—what does the Hansen–Jagannathan distance tell us?," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 853-879.
    • Handle: RePEc:eee:reveco:v:71:y:2021:i:c:p:853-879
    DOI: 10.1016/j.iref.2020.10.013
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    More about this item

    Keywords

    Tradable and nontradable factors; Hansen–Jagannathan distance; Misspecification errors; Factors mimicking portfolios;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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