Improvement In Finite Sample Properties Of The Hansen-jagannathan Distance Test

Yu Ren () and Katsumi Shimotsu
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Katsumi Shimotsu: Department of Economics, Queen's University

No 1126, Working Paper from Economics Department, Queen's University

Abstract: Jagannathan and Wang (1996) derive the asymptotic distribution ofthe Hansen-Jagannathan distance (HJ-distance) proposed by Hansenand Jagannathan (1997), and develop a specification test of assetpricing models based on the HJ-distance. While the HJ-distance hasseveral desirable properties, Ahn and Gadarowski (2004) find thatthe specification test based on the HJ-distance overrejectscorrect models too severely in commonly used sample size toprovide a valid test. This paper proposes to improve the finite sample properties of the HJ-distance test by applying the shrinkage method (Ledoit and Wolf, 2003) to compute its weighting matrix. The proposed method improves the finite sample performance of the HJ-distance test significantly.

Keywords: Covariance matrix estimation; Factor models; Finite sample properties; Hansen-Jagannathan distance; Shrinkage method (search for similar items in EconPapers)
JEL-codes: C13 C52 G12 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2007-06
New Economics Papers: this item is included in nep-ecm
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https://www.econ.queensu.ca/sites/econ.queensu.ca/files/qed_wp_1126.pdf First version 2007 (application/pdf)

Related works:
Journal Article: Improvement in finite sample properties of the Hansen-Jagannathan distance test (2009)
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