Empirical evaluation of asset pricing models: arbitrage and pricing errors over contingent claims

Zhenyu Wang and Xiaoyan Zhang ()

No 265, Staff Reports from Federal Reserve Bank of New York

Abstract: In a 1997 paper, Hansen and Jagannathan develop two pricing error measures for asset pricing models. The first measure is the maximum pricing error on given test assets, and the second measure is the maximum pricing error over all possible contingent claims. We develop a simulation-based Bayesian inference of the pricing error measures. Although linear time-varying and multifactor models are widely reported to have small pricing errors on standard test assets, we demonstrate that these models can have large pricing errors over contingent claims because their stochastic discount factors are allowed to be negative and thus offer arbitrage opportunities.

Keywords: Asset pricing; Arbitrage; Pricing (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-cfn
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