Empirical evaluation of asset pricing models: Arbitrage and pricing errors in contingent claims

Zhenyu Wang and Xiaoyan Zhang ()

Journal of Empirical Finance, 2012, vol. 19, issue 1, 65-78

Abstract: Hansen and Jagannathan (1997) have developed two measures of pricing errors for asset-pricing models: the maximum pricing error in all static portfolios of the test assets and the maximum pricing error in all contingent claims of the assets. In this paper, we develop simulation-based Bayesian inference for these measures. While the literature reports that the time-varying extensions substantially reduce pricing errors of classic models on the standard test assets, our analysis shows that the reduction is much smaller based on the second measure. Those time-varying models have large pricing errors on the contingent claims of the test assets because their stochastic discount factors are often negative and admit arbitrage opportunities.

Keywords: Bayesian inference; Asset pricing; Pricing errors; Model comparison; Contingent claims (search for similar items in EconPapers)
JEL-codes: G1 G12 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:19:y:2012:i:1:p:65-78

DOI: 10.1016/j.jempfin.2011.11.001

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