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A simple test of misspecification for linear asset pricing models

Author

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  • Antoine Giannetti

    (Florida Atlantic University)

Abstract

A fundamental implication of asset pricing theory is that investors must earn risk-premiums for bearing exposure to systematic risk. The two-pass cross-sectional regression is a popular approach for risk-premium estimation. The empirical literature has found that this approach often delivers estimates that significantly differ from their time-series counterparts. The paper explores a test of model misspecification that exploits the difference between cross-sectional and time-series risk-premium estimates. The suggested approach complements traditional misspecification tests and may be applied as an alternative to the deployment of misspecification-robust standard errors to test risk-premium significance.

Suggested Citation

  • Antoine Giannetti, 2024. "A simple test of misspecification for linear asset pricing models," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 38(3), pages 305-330, September.
    • Handle: RePEc:kap:fmktpm:v:38:y:2024:i:3:d:10.1007_s11408-024-00445-6
    DOI: 10.1007/s11408-024-00445-6
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    More about this item

    Keywords

    Asset pricing; Risk-premium; Model misspecification; Simulations;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General

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