General Tests of Latent Variable Models and Mean Variance Spanning (Reprint 031)

Wayne Ferson (), Stephen R. Foerster and Donald Keim ()

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: The methods of Gibbons and Ferson (1985) are extended, relaxing the assumption that expected returns are linear functions of predetermined instruments. A model of conditional mean variance spanning generalizes Huberman and Kandel (1987). The empirical results indicate that more than a single risk premium is needed to model expected stock and bond returns, but the number of common factors in the expected returns is small. However, when size-biased common stock portfolios proxy for the risk factors, we reject the hypothesis that four of them describe the conditional expected returns of the other assets.

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