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

Xiang Zhang, Yangyi Liu, Kun Wu and Bertrand Maillet

International Review of Economics & Finance, 2021, vol. 71, issue C, 853-879

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)
JEL-codes: G1 G12 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:71:y:2021:i:c:p:853-879

DOI: 10.1016/j.iref.2020.10.013

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