Working Paper: NBER ID: w16457
Authors: Stefan Nagel; Kenneth J Singleton
Abstract: We find that several recently proposed consumption-based models of stock returns, when evaluated using an optimal set of managed portfolios and the associated model-implied conditional moment restrictions, fail to capture key features of risk premiums in equity markets. To arrive at these conclusions, we construct an optimal GMM estimator for models in which the stochastic discount factor (SDF) is a conditionally affine function of a set of priced risk factors. Further, for the (often relevant) case where a researcher is proposing a generalized SDF relative to some null model, we show that there is an optimal choice of managed portfolios to use in testing the null against the proposed alternative.
Keywords: Consumption-based models; Asset pricing; Stochastic discount factor; Generalized method of moments; Risk premiums
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Consumption-based models (D12) | Fail to capture risk premiums in equity markets (G12) |
| Stochastic discount factor (SDF) (D15) | Conditioned on priced risk factors (G19) |
| Optimal GMM estimator (C51) | More reliable assessment of models (C52) |
| Optimal choice of managed portfolios (G11) | Enhances statistical power of goodness-of-fit tests (C52) |
| Existing models (C59) | Do not pass standard diagnostic tests (C22) |
| Models fit unconditional moments well (C51) | Produce counterfactual variation in conditional moments (C51) |
| Challenges for asset pricing models (G19) | Need for nuanced understanding of conditional distribution of returns (C46) |