GMM weighting matrices incross-sectional asset pricing tests

Nora Laurinaityte, Christoph Meinerding, Christian Schlag and Julian Thimme

No 62/2020, Discussion Papers from Deutsche Bundesbank

Abstract: Cross-sectional asset pricing tests with GMM can generate spuriouslyhigh explanatory power for factor models when the moment conditions are specifiedsuch that they allow the estimated factor means to substantially deviate from theobserved sample averages. In fact, by shifting the weights on the moment conditions,any level of cross-sectional fit can be attained. This property is a feature of the GMMestimation design and applies to strong as well as weak factors, and to all samplesizes and test assets. We reveal the origins of this bias theoretically, gauge its sizeusing simulations, and document its relevance empirically.

Keywords: asset pricing; cross-section of expected returns; GMM; factor zoo (search for similar items in EconPapers)
JEL-codes: C13 C21 G00 G12 (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-ecm and nep-ore
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdps:622020

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