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

Xiang Zhang, Yangyi Liu, Kun Wu and Bertrand Maillet ()

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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.

Keywords: Tradable and nontradable factors; Hansen–Jagannathan distance; Misspecification errors; Factors mimicking portfolios (search for similar items in EconPapers)
Date: 2021-01-01
New Economics Papers: this item is included in nep-isf
Note: View the original document on HAL open archive server: https://hal.science/hal-03287946
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Citations: View citations in EconPapers (1)

Published in International Review of Economics and Finance, 2021, 71, 853-879 p

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Journal Article: Tradable or nontradable factors—what does the Hansen–Jagannathan distance tell us? (2021)
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