34 results on '"Cesare Robotti"'
Search Results
2. The Exact Distribution of the Hansen-Jagannathan Bound.
- Author
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Raymond Kan and Cesare Robotti
- Published
- 2016
- Full Text
- View/download PDF
3. Common pricing across asset classes: Empirical evidence revisited
- Author
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Cesare Robotti and Nikolay Gospodinov
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040101 forestry ,Economics and Econometrics ,050208 finance ,Actuarial science ,Strategy and Management ,Sharpe ratio ,05 social sciences ,Downside risk ,Asset allocation ,Efficient frontier ,04 agricultural and veterinary sciences ,HG ,Traditional economy ,Empirical research ,Accounting ,0502 economics and business ,Economics ,0401 agriculture, forestry, and fisheries ,Capital asset pricing model ,Empirical evidence ,Finance - Abstract
Intermediary and downside-risk asset-pricing theories lay the foundations for spanning the multi-asset return space by a small number of risk factors. Recent studies document strong empirical\ud support for such factors across major asset classes. We revisit these results and show that robust evidence for common factor pricing remains elusive. Importantly, the proposed risk factors do not\ud seem to provide incremental information to the traditional market factor. We argue that most of the economic and statistical challenges are not specific to these analyses and, with the aid of a placebo test, offer general recommendations for improving empirical tests, thus adding to the prescriptions in Lewellen, Nagel, and Shanken (2010).
- Published
- 2021
4. Are the Primary Dealers of the New York Fed Really Special?
- Author
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Danilo Antonino Giannone and Cesare Robotti
- Subjects
History ,Polymers and Plastics ,Business and International Management ,Industrial and Manufacturing Engineering - Published
- 2022
5. Comment on: Pseudo-True SDFs in Conditional Asset Pricing Models
- Author
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Cesare Robotti and Raymond Kan
- Subjects
Economics and Econometrics ,Econometrics ,Capital asset pricing model ,Finance ,Mathematics - Published
- 2020
6. Testing Beta-Pricing Models Using Large Cross-Sections
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Valentina Raponi, Paolo Zaffaroni, and Cesare Robotti
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Economics and Econometrics ,Economics ,Risk premium ,Monte Carlo method ,Social Sciences ,1401 Economic Theory ,Context (language use) ,RISK PREMIA ,HG ,Business economics ,Business & Economics ,two-pass ,risk premia ,asymptotic ,factor models ,Accounting ,Statistics ,Econometrics ,Relevance (information retrieval) ,QA ,Beta (finance) ,1402 Applied Economics ,Mathematics ,DISCOUNT FACTOR MODELS ,IDENTIFICATION ,ARBITRAGE ,1502 Banking, Finance and Investment ,ROBUST INFERENCE ,Estimator ,MIMICKING PORTFOLIOS ,PERFORMANCE ,Investment (macroeconomics) ,Business, Finance ,RETURNS ,Identification (information) ,Arbitrage ,Constant (mathematics) ,Finance - Abstract
We propose a methodology for estimating and testing beta-pricing models when a large number of assets is available for investment but the number of time-series observations is fixed. We first consider the case of correctly specified models with constant risk premia, and then extend our framework to deal with time-varying risk premia, potentially misspecified models, firm characteristics, and unbalanced panels. We show that our large cross-sectional framework poses a serious challenge to common empirical findings regarding the validity of beta-pricing models. In the context of pricing models with Fama-French factors, firm characteristics are found to explain a much larger proportion of variation in estimated expected returns than betas. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.
- Published
- 2019
7. On Moments of Folded and Truncated Multivariate Normal Distributions
- Author
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Cesare Robotti and Raymond Kan
- Subjects
Statistics and Probability ,Recurrence relation ,Truncated normal distribution ,Computation ,Mathematical analysis ,Matrix t-distribution ,020206 networking & telecommunications ,Multivariate normal distribution ,02 engineering and technology ,01 natural sciences ,Normal-Wishart distribution ,010104 statistics & probability ,0202 electrical engineering, electronic engineering, information engineering ,Order (group theory) ,Discrete Mathematics and Combinatorics ,Matrix normal distribution ,0101 mathematics ,Statistics, Probability and Uncertainty ,Elliptical distribution ,Folded normal distribution ,Multivariate stable distribution ,Mathematics - Abstract
Recurrence relations for integrals that involve the density of multivariate normal distributions are developed. These recursions allow fast computation of the moments of folded and truncated multivariate normal distributions. Besides being numerically efficient, the proposed recursions also allow us to obtain explicit expressions of low-order moments of folded and truncated multivariate normal distributions. Supplementary material for this article is available online.
- Published
- 2017
8. Too good to be true? Fallacies in evaluating risk factor models
- Author
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Nikolay Gospodinov, Raymond Kan, and Cesare Robotti
- Subjects
040101 forestry ,Economics and Econometrics ,050208 finance ,Strategy and Management ,Maximum likelihood ,05 social sciences ,04 agricultural and veterinary sciences ,Risk factor (finance) ,HG ,Correlation ,Identification (information) ,Goodness of fit ,Accounting ,0502 economics and business ,Econometrics ,Statistical inference ,0401 agriculture, forestry, and fisheries ,Capital asset pricing model ,Spurious relationship ,Finance ,Mathematics - Abstract
This paper is concerned with statistical inference and model evaluation in possibly misspecified and unidentified linear asset-pricing models estimated by maximum likelihood. Strikingly, when spurious factors (that is, factors that are uncorrelated with the returns on the test assets) are present, the models exhibit perfect fit, as measured by the squared correlation between the model's fitted expected returns and the average realized returns. Furthermore, factors that are spurious are selected with high probability, while factors that are useful are driven out of the model. While ignoring potential misspecification and lack of identification can be very problematic for models with macroeconomic factors, empirical specifications with traded factors (e.g., Fama and French, 1993, and Hou, Xue, and Zhang, 2015) do not suffer of the identification problems documented in this study.
- Published
- 2019
9. On the properties of the constrained Hansen–Jagannathan distance
- Author
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Raymond Kan, Nikolay Gospodinov, and Cesare Robotti
- Subjects
Economics and Econometrics ,Multivariate statistics ,050208 finance ,Rank (linear algebra) ,Constrained Hansen-Jagannathan distance ,No-arbitrage ,05 social sciences ,Sample (statistics) ,Constraint (information theory) ,symbols.namesake ,Stochastic discount factor ,Lagrange multiplier ,0502 economics and business ,Linear SDFs ,1403 Econometrics ,symbols ,Economics ,Applied mathematics ,1502 Banking, Finance And Investment ,050207 economics ,Asset-pricing models ,Elliptical distribution ,Mathematical economics ,Finance ,Equity pricing - Abstract
We provide an in-depth analysis of the theoretical properties of the Hansen–Jagannathan (HJ) distance that incorporates a no-arbitrage constraint. Under a multivariate elliptical distribution assumption, we present explicit expressions for the HJ-distance with a no-arbitrage constraint, the associated Lagrange multipliers, and the stochastic discount factor (SDF) parameters in the case of linear SDFs. This allows us to analyze the benefits and costs of using the HJ-distance with a no-arbitrage constraint to evaluate and rank models. We also study the asymptotic and finite-sample properties of the sample constrained HJ-distance. Finally, we demonstrate the practical relevance of our theoretical findings in an empirical illustration of some popular asset-pricing models.
- Published
- 2016
10. Model Comparison with Sharpe Ratios
- Author
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Raymond Kan, Cesare Robotti, Jay Shanken, and Francisco Barillas
- Subjects
Modigliani risk-adjusted performance ,Ranking ,Sharpe ratio ,Statistics ,Value (economics) ,Econometrics ,Statistical inference ,Economics ,Portfolio ,Dominant model ,Measure (mathematics) - Abstract
We show how to conduct asymptotically valid tests of model comparison when the extent of model mispricing is gauged by the squared Sharpe ratio improvement measure. This is equivalent to ranking models on their maximum Sharpe ratios, effectively extending the GRS test to accommodate comparison of non-nested models. Mimicking portfolios can be substituted for any nontraded model factors and estimation error in the portfolio weights is taken into account in the statistical inference. A variant of the Fama and French (2018) six-factor model, with a monthly-updated version of the usual value spread, emerges as the dominant model.
- Published
- 2017
11. Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology
- Author
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Cesare Robotti, Jay Shanken, and Raymond Kan
- Subjects
Economics and Econometrics ,education.field_of_study ,Risk premium ,Population ,Asymptotic distribution ,Sample (statistics) ,Cross-sectional regression ,Accounting ,Statistical inference ,Economics ,Econometrics ,Capital asset pricing model ,Asset (economics) ,education ,Finance - Abstract
Since Black, Jensen, and Scholes (1972) and Fama and MacBeth (1973), the two-pass cross- sectional regression (CSR) methodology has become the most popular approach for estimating and testing asset pricing models. Statistical inference with this method is typically conducted under the assumption that the models are correctly specified, that is, expected returns are exactly linear in asset betas. This assumption can be a problem in practice since all models are, at best, approximations of reality and are likely to be subject to a certain degree of misspecification. We propose a general methodology for computing misspecification-robust asymptotic standard errors of the risk premia estimates. We also derive the asymptotic distribution of the sample CSR R 2 and develop a test of whether two competing linear beta pricing models have the same population R 2 . This test provides a formal alternative to the common heuristic of simply comparing the R 2 estimates in evaluating relative model performance. Finally, we provide an empirical application, which demonstrates the importance of our new results when applied to a variety of asset pricing models. JEL classification: G12
- Published
- 2013
12. Further Results on the Limiting Distribution of GMM Sample Moment Conditions
- Author
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Raymond Kan, Nikolay Gospodinov, and Cesare Robotti
- Subjects
Statistics and Probability ,Asymptotic analysis ,Economics and Econometrics ,Rank (linear algebra) ,05 social sciences ,V-statistic ,Asymptotic distribution ,01 natural sciences ,Moment (mathematics) ,Normal distribution ,010104 statistics & probability ,Discontinuity (linguistics) ,Sampling distribution ,Statistics ,0502 economics and business ,Statistical inference ,Applied mathematics ,0101 mathematics ,Statistics, Probability and Uncertainty ,Linear combination ,Degeneracy (mathematics) ,Social Sciences (miscellaneous) ,050205 econometrics ,Mathematics ,Generalized method of moments - Abstract
In this article, we examine the limiting behavior of generalized method of moments (GMM) sample moment conditions and point out an important discontinuity that arises in their asymptotic distribution. We show that the part of the scaled sample moment conditions that gives rise to degeneracy in the asymptotic normal distribution is T-consistent and has a nonstandard limiting distribution. We derive the appropriate asymptotic (weighted chi-squared) distribution when this degeneracy occurs and show how to conduct asymptotically valid statistical inference. We also propose a new rank test that provides guidance on which (standard or nonstandard) asymptotic framework should be used for inference. The finite-sample properties of the proposed asymptotic approximation are demonstrated using simulated data from some popular asset pricing models.
- Published
- 2012
13. Model Comparison Using the Hansen-Jagannathan Distance
- Author
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Raymond Kan and Cesare Robotti
- Subjects
Economics and Econometrics ,Standard error ,Simple (abstract algebra) ,Stochastic discount factor ,Computer science ,Accounting ,Risk premium ,Econometrics ,Test statistic ,Asymptotic distribution ,Capital asset pricing model ,Finance ,Test (assessment) - Abstract
Although it is of interest to test whether or not a particular asset pricing model is literally true, a more useful task for empirical researchers is to determine how wrong a model is and to compare the performance of competing asset pricing models. In this paper, we propose a new methodology to test whether or not two competing linear asset pricing models have the same Hansen-Jagannathan distance. We show that the asymptotic distribution of the test statistic depends on whether the competing models are correctly specified or misspecified, and on whether the competing models are nested or non-nested. In addition, given the increasing interest in misspecified models, we propose a simple methodology for computing the standard errors of the estimated stochastic discount factor parameters that are robust to model misspecification. Using monthly data on 25 size and book-to-market ranked portfolios and the one-month T-bill, we show that the commonly used returns and factors are, for the most part, too noisy for us to conclude that one model is superior to the other models in terms of Hansen-Jagannathan distance. Specifically, there is little evidence that conditional and intertemporal capital asset pricing model (CAPM)-type specifications outperform the simple unconditional CAPM. In addition, we show that many of the macroeconomic factors commonly used in the literature are no longer priced once potential model misspecification is taken into account. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
- Published
- 2008
14. Spurious Inference in Unidentified Asset-Pricing Models
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Nikolay Gospodinov, Raymond Kan, and Cesare Robotti
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050208 finance ,05 social sciences ,Estimator ,Inference ,Nominal size ,Arbitrarily large ,Specification ,0502 economics and business ,Statistics ,Econometrics ,Capital asset pricing model ,Spurious relationship ,050205 econometrics ,Generalized method of moments ,Mathematics - Abstract
This paper studies some seemingly anomalous results that arise in possibly misspecified and unidentified linear asset-pricing models estimated by maximum likelihood and one-step generalized method of moments (GMM). Strikingly, when useless factors (that is, factors that are independent of the returns on the test assets) are present, the models exhibit perfect fit, as measured by the squared correlation between the model's fitted expected returns and the average realized returns, and the tests for correct model specification have asymptotic power that is equal to the nominal size. In other words, applied researchers will erroneously conclude that the model is correctly specified even when the degree of misspecification is arbitrarily large. We also derive the highly nonstandard limiting behavior of these invariant estimators and their t-tests in the presence of identification failure. These results reveal the spurious nature of inference as useless factors are selected with high probability, while useful factors are driven out from the model. The practical relevance of our findings is demonstrated using simulations and an empirical application.
- Published
- 2014
15. Misspecification-robust inference in linear asset pricing models with irrelevant risk factors
- Author
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Cesare Robotti, Nikolay Gospodinov, and Raymond Kan
- Subjects
Economics and Econometrics ,Computer science ,Inference ,HG ,Accounting ,0502 economics and business ,Econometrics ,Economics ,Capital asset pricing model ,Relevance (information retrieval) ,050207 economics ,040101 forestry ,High probability ,050208 finance ,jel:C52 ,Model selection ,05 social sciences ,jel:C12 ,04 agricultural and veterinary sciences ,Asset return ,jel:G12 ,Uncorrelated ,Identification (information) ,0401 agriculture, forestry, and fisheries ,asset pricing models ,lack of identification ,model misspecification ,GMM estimation ,Finance ,Statistical evidence - Abstract
This paper shows that in misspecified models with risk factors that are uncorrelated with the test asset returns, the conventional inference methods tend to erroneously conclude, with high probability, that these factors are priced. Our proposed model selection procedure, which is robust to identification failure and potential model misspecification, restores the standard inference and proves to be effective in eliminating factors that do not improve the model's pricing ability. Applying our methodology to several popular asset-pricing models suggests that only the market and book-to-market factors appear to be priced, while the statistical evidence on the pricing ability of many macroeconomic factors is rather weak.
- Published
- 2013
16. Robust Inference in Linear Asset Pricing Models
- Author
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Nikolay Gospodinov, Cesare Robotti, and Raymond Kan
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050208 finance ,Model selection ,0502 economics and business ,05 social sciences ,Econometrics ,Economics ,Inference ,Capital asset pricing model ,Relevance (information retrieval) ,050207 economics ,Asset return - Abstract
We derive new results on the asymptotic behavior of the estimated parameters of a linear asset pricing model and their associated t-statistics in the presence of a factor that is independent of the returns. The inclusion of this "useless" factor in the model leads to a violation of the full rank (identification) condition and renders the inference nonstandard. We show that the estimated parameter associated with the useless factor diverges with the sample size but the misspecification-robust t-statistic is still well-behaved and has a standard normal limiting distribution. The asymptotic distributions of the estimates of the remaining parameters and the model specification test are also affected by the presence of a useless factor and are nonstandard. We propose a robust and easy-to-implement model selection procedure that restores the standard inference on the parameters of interest by identifying and removing the factors that do not contribute to improved pricing. The finite-sample properties of our asymptotic approximations and the practical relevance of our results are illustrated using simulations and an empirical application.
- Published
- 2012
17. Analytical solution for the constrained Hansen-Jagannathan distance under multivariate ellipticity
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Cesare Robotti, Raymond Kan, and Nikolay Gospodinov
- Subjects
Multivariate statistics ,Mathematical optimization ,050208 finance ,Rank (linear algebra) ,05 social sciences ,Mathematics::Optimization and Control ,Constraint (information theory) ,symbols.namesake ,Computer Science::Computational Engineering, Finance, and Science ,Lagrange multiplier ,0502 economics and business ,symbols ,Capital asset pricing model ,050207 economics ,Elliptical distribution ,Mathematics - Abstract
We provide an in-depth analysis of the theoretical properties of the Hansen-Jagannathan (HJ) distance that incorporates a no-arbitrage constraint. Under a multivariate elliptical distribution assumption, we present explicit expressions for the HJ-distance with a no-arbitrage constraint, the associated Lagrange multipliers, and the SDF parameters in the case of linear SDFs. This approach allows us to analyze the benefits and costs of using the HJ-distance with a no-arbitrage constraint to rank asset pricing models.
- Published
- 2012
18. Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology
- Author
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Jay Shanken, Raymond Kan, and Cesare Robotti
- Subjects
Intertemporal CAPM ,Investment theory ,Econometrics ,Arbitrage pricing theory ,Economics ,Capital asset pricing model ,Asymptotic distribution ,Cross-sectional regression ,Statistic ,Regression - Abstract
Over the years, many asset pricing studies have employed the sample cross-sectional regression (CSR) R2 as a measure of model performance. We derive the asymptotic distribution of this statistic and develop associated model comparison tests, taking into account the inevitable impact of model misspecification on the variability of the two-pass CSR estimates. We encounter several examples of large R2 differences that are not statistically significant. A version of the intertemporal CAPM exhibits the best overall performance, followed by the "three-factor model" of Fama and French (1993). Interestingly, the performance of prominent consumption CAPMs proves to be sensitive to variations in experimental design.
- Published
- 2012
19. Chi-squared tests for evaluation and comparison of asset pricing models
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Raymond Kan, Nikolay Gospodinov, and Cesare Robotti
- Subjects
Economics and Econometrics ,Measure (data warehouse) ,050208 finance ,Computer science ,Applied Mathematics ,Consumption-based capital asset pricing model ,Model selection ,05 social sciences ,1. No poverty ,Limiting ,Measure (mathematics) ,Nonlinear system ,Investment theory ,0502 economics and business ,8. Economic growth ,Chi-square test ,Econometrics ,Arbitrage pricing theory ,Capital asset pricing model ,Cover (algebra) ,050207 economics ,Rational pricing ,Mathematics ,050205 econometrics - Abstract
Using data for the Philippines, I develop and estimate a heterogeneous agent model to analyze the role of monetary policy in a small open economy subject to sizable remittance fluctuations. I include rule-of-thumb households with no access to financial markets and test whether remittances are countercyclical and serve as an insurance mechanism against macroeconomic shocks. When evaluating the welfare implications of alternative monetary rules, I consider both an anticipated large secular increase in the trend growth of remittances and random cyclical fluctuations around this trend. In a purely deterministic framework, a nominal fixed exchange rate regime avoids a rapid real appreciation and performs better for recipient households facing an increasing trend for remittances. A flexible floating regime is preferred when unanticipated shocks driving the business cycle are also part of the picture.
- Published
- 2011
20. On the Hansen-Jagannathan distance with a no-arbitrage constraint
- Author
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Cesare Robotti, Nikolay Gospodinov, and Raymond Kan
- Subjects
050208 finance ,Sharpe ratio ,media_common.quotation_subject ,05 social sciences ,Function (mathematics) ,Constraint (information theory) ,symbols.namesake ,Stochastic discount factor ,Lagrange multiplier ,0502 economics and business ,Econometrics ,symbols ,Arbitrage ,050207 economics ,Volatility (finance) ,Normality ,Mathematics ,media_common - Abstract
We provide an in-depth analysis of the theoretical and statistical properties of the Hansen- Jagannathan (HJ) distance that incorporates a no-arbitrage constraint. We show that for stochastic discount factors (SDF) that are spanned by the returns on the test assets, testing the equality of HJ distances with no-arbitrage constraints is the same as testing the equality of HJ distances without no- arbitrage constraints. A discrepancy can exist only when at least one SDF is a function of factors that are poorly mimicked by the returns on the test assets. Under a joint normality assumption on the SDF and the returns, we derive explicit solutions for the HJ distance with a no-arbitrage constraint, the associated Lagrange multipliers, and the SDF parameters in the case of linear SDFs. This solution allows us to show that nontrivial differences between HJ distances with and without no-arbitrage constraints can arise only when the volatility of the unspanned component of an SDF is large and the Sharpe ratio of the tangency portfolio of the test assets is very high. Finally, we present the appropriate limiting theory for estimation, testing, and comparison of SDFs using the HJ distance with a no-arbitrage constraint.
- Published
- 2010
21. Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology
- Author
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Raymond Kan, Cesare Robotti, and Jay Shanken
- Published
- 2009
22. Asset Pricing Models and Economic Risk Premia: A Decomposition
- Author
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Pierluigi Balduzzi and Cesare Robotti
- Subjects
Economics and Econometrics ,Economic factor ,Stochastic discount factor ,Risk premium ,Decomposition (computer science) ,Economics ,Dividend yield ,Econometrics ,Capital asset pricing model ,Covariance ,Investment (macroeconomics) ,Finance - Abstract
The risk premia of linear factor models on economic (non-traded) risk factors can be decomposed into: i) the premium on maximum-correlation portfolios mimicking the factors; ii) (minus) the covariance between the non-traded components of the pricing kernel and the factors; and iii) (minus) the mispricing of the maximum-correlation portfolios. For a given set of assets available for investment, the first component is the same across models and is typically estimated with little bias and high precision. We conclude that the premia on maximum-correlation portfolios are appealing alternatives to the risk premia of linear factor models, with the dividend yield being the only economic factor significantly priced.
- Published
- 2009
23. On the Estimation of Asset Pricing Models Using Univariate Betas
- Author
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Cesare Robotti and Raymond Kan
- Subjects
Estimation ,Economics and Econometrics ,Standard error ,Risk premium ,Economics ,Univariate ,Econometrics ,Robust statistics ,Capital asset pricing model ,Finance ,Regression ,Mathematics - Abstract
We derive asymptotic standard errors of risk premia estimates based on the popular two-pass cross-sectional regression methodology developed by Black, Jensen, and Scholes (1972) and Fama and MacBeth (1973) when univariate betas are used as regressors. Our standard errors are robust to model misspecification and allow for general distributional assumptions. In testing whether the beta risk of a given factor is priced, our misspecification robust standard error can lead to economically different conclusions from those based on the Jagannathan and Wang (1998) standard error which is derived under the correctly specified model.
- Published
- 2009
24. A note on the estimation of asset pricing models using simple regression betas
- Author
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Raymond Kan and Cesare Robotti
- Subjects
Model selection ,Risk premium ,Asset pricing ,Econometric models ,Ordinary least squares ,Linear regression ,Econometrics ,Arbitrage pricing theory ,Economics ,Capital asset pricing model ,Simple linear regression ,Time series - Abstract
Working Paper 2009-12 March 2009 Abstract: Since Black, Jensen, and Scholes (1972) and Fama and MacBeth (1973), the two-pass cross-sectional regression (CSR) methodology has become the most popular tool for estimating and testing beta asset pricing models. In this paper, we focus on the case in which simple regression betas are used as regressors in the second-pass CSR. Under general distributional assumptions, we derive asymptotic standard errors of the risk premia estimates that are robust to model misspecification. When testing whether the beta risk of a given factor is priced, our misspecification robust standard error and the Jagannathan and Wang (1998) standard error (which is derived under the correctly specified model) can lead to different conclusions. JEL classification: G12 Key words: two-pass cross-sectional regressions, risk premia, model misspecification, simple regression betas, multivariate betas Introduction In the empirical asset pricing literature, the popular two-pass cross-sectional regression (CSR) methodology developed by Black, Jensen, and Scholes (1972) and Fama and MacBeth (1973) is often used for estimating risk premia and testing pricing models that relate expected security returns to security betas on economic factors (beta pricing models). Although there are many variations of this two-pass methodology, its basic approach always involves two steps. In the first pass, the betas of the test assets are estimated using the usual ordinary least squares (OLS) time series regression of returns on some common factors. In the second pass, the returns on test assets are regressed on the estimated betas obtained from the first pass. By running this second-pass CSR on a period-by-period basis, we obtain time series of the intercept and the slope coefficients. The average values of the intercept and the slope coefficients are then used as estimates of the zero-beta rate and the risk premia. Usually, asset betas are defined as the OLS slope coefficients in the multiple regression of asset returns on factors and are referred to as multiple regression or multivariate betas. However, there is a potential issue with the use of multiple regression betas: unless the factors are uncorrelated, the beta of an asset with respect to a particular factor in general depends on what other factors are included in the first-pass time series OLS regression. As a result, a factor can possess additional explanatory power for the cross-sectional differences in expected returns but yet have a zero risk premium in a model with multiple factors. This makes it problematic to use the risk premium of a factor for the purpose of model selection. To overcome this problem, Chen, Roll, and Ross (1986) and Jagannathan and Wang (1996, 1998) define the beta of an asset with respect to a given factor as the OLS slope coefficient in a simple regression of its return on the factor. These betas are normally referred to as simple regression or univariate betas. In models with simple regression betas, adding or deleting a factor in a model will not change the values of the betas corresponding to the other factors and selecting models based on risk premia becomes more meaningful. (1) Jagannathan and Wang (1998) present an asymptotic theory for models with simple regression betas. (2) However, their asymptotic results rest on the assumption that expected returns are exactly linear in the betas, i.e., the beta pricing model is correctly specified. It is difficult to justify this assumption when estimating the zero-beta rate and risk premia parameters for many different models because some (if not all) of the models are bound to be misspecified. Since asset pricing models are, at best, approximations of reality, it is inevitable that we will often, knowingly or unknowingly (since asset pricing tests have limited power), estimate an expected return relation that departs from exact linearity in the betas. …
- Published
- 2009
25. The Exact Distribution of the Hansen-Jagannathan Bound
- Author
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Cesare Robotti and Raymond Kan
- Subjects
Technology ,Operations Research ,ASSET-PRICING-MODELS ,Strategy and Management ,media_common.quotation_subject ,Population ,Social Sciences ,Hansen-Jagannathan bounds ,Multivariate normal distribution ,Sample (statistics) ,Management Science and Operations Research ,MARKETS ,Hansen–Jagannathan bound ,Stochastic discount factor ,Business & Economics ,0502 economics and business ,PORTFOLIO ,Econometrics ,Applied mathematics ,RATES ,050207 economics ,education ,Normality ,media_common ,Mathematics ,maximum likelihood estimators ,08 Information And Computing Sciences ,education.field_of_study ,050208 finance ,Science & Technology ,Mathematics::Combinatorics ,Operations Research & Management Science ,CONDITIONING INFORMATION ,05 social sciences ,STOCHASTIC DISCOUNT FACTOR ,MILLS RATIO ,Variance (accounting) ,RETURNS ,Confidence interval ,Management ,Inverse Mills ratio ,Constraint (information theory) ,finite-sample distributions ,in-sample arbitrage portfolios ,TESTS ,15 Commerce, Management, Tourism And Services - Abstract
Under the assumption of multivariate normality of asset returns, this paper presents a geometric interpretation and the finite-sample distributions of the sample Hansen–Jagannathan bounds on the variance of admissible stochastic discount factors, with and without the nonnegativity constraint on the stochastic discount factors. In addition, since the sample Hansen–Jagannathan bounds can be very volatile, we propose a simple method to construct confidence intervals for the population Hansen–Jagannathan bounds. Finally, we show that the analytical results in the paper are robust to departures from the normality assumption. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2222 . This paper was accepted by Jerome Detemple, operations management.
- Published
- 2008
26. Asset-pricing models and economic risk premia: a decomposition
- Author
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Pierluigi Balduzzi and Cesare Robotti
- Subjects
Stochastic discount factor ,Financial economics ,Risk premium ,Component (UML) ,Econometrics ,Decomposition (computer science) ,Capital asset pricing model ,Risk factor (finance) ,Covariance ,Constant (mathematics) ,Mathematics - Abstract
The risk premia assigned to economic (non-traded) risk factors can be decomposed into three parts: i) the risk premia on maximum-correlation portfolios mimicking the factors; ii) (minus) the covariance between the non-traded components of the candidate pricing kernel of a given model and the factors; and iii) (minus) the mis-pricing assigned by the candidate pricing kernel to the maximum-correlation mimicking portfolios. The first component is the same across asset-pricing models, and is typically estimated with little (absolute) bias and high precision. The second component, on the other hand, is essentially arbitrary, and can be estimated with large (absolute) biases and low precisions by multi-beta models with non-traded factors. This second component is also sensitive to the criterion minimized in estimation. The third component is estimated reasonably well, both for models with traded and non-traded factors. We conclude that the economic risk premia assigned by multi-beta models with non-traded factors can be very unreliable. Conversely, the risk premia on maximum-correlation portfolios provide more reliable indications of whether a non-traded risk factor is priced. These results hold for both the constant and the time-varying components of the factor risk premia.
- Published
- 2005
27. Mimicking portfolios, economic risk premia, and tests of multi-beta models
- Author
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Cesare Robotti and Pierluigi Balduzzi
- Subjects
Statistics and Probability ,Economics and Econometrics ,Series (mathematics) ,Risk premium ,Regression ,Economic risk ,Statistics ,Economics ,Econometrics ,Statistics, Probability and Uncertainty ,Excess return ,Beta (finance) ,Social Sciences (miscellaneous) ,Linear factor ,Mathematics ,Statistical hypothesis testing - Abstract
This paper considers two alternative formulations of the linear factor model (LFM) with nontraded factors. The first formulation is the traditional LFM, where the estimation of risk premia and alphas is performed by means of a cross-sectional regression of average returns on betas. The second formulation (LFM*) replaces the factors with their projections on the span of excess returns. This formulation requires only time-series regressions for the estimation of risk premia and alphas. We compare the theoretical properties of the two approaches and study the small-sample properties of estimates and test statistics. Our results show that when estimating risk premia and testing multi-beta models, the LFM* formulation should be considered in addition to, or even instead of, the more traditional LFM formulation.
- Published
- 2005
28. Playing the Field: Geomagnetic Storms and the Stock Market
- Author
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Anna Krivelyova and Cesare Robotti
- Subjects
Empirical research ,Mood ,Financial economics ,media_common.quotation_subject ,Economics ,Stock market ,Misattribution of memory ,Pessimism ,Behavioral economics ,Stock market index ,Stock (geology) ,media_common - Abstract
Explaining movements in daily stock prices is one of the most difficult tasks in modern finance. This paper contributes to the existing literature by documenting the impact of geomagnetic storms on daily stock market returns. A large body of psychological research has shown that geomagnetic storms have a profound effect on people's moods, and, in turn, people's moods have been found to be related to human behavior, judgments and decisions about risk. An important finding of this literature is that people often attribute their feelings and emotions to the wrong source, leading to incorrect judgments. Specifically, people affected by geomagnetic storms may be more inclined to sell stocks on stormy days because they incorrectly attribute their bad mood to negative economic prospects rather than bad environmental conditions. Misattribution of mood and pessimistic choices can translate into a relatively higher demand for riskless assets, causing the price of risky assets to fall or to rise less quickly than otherwise. The authors find strong empirical support in favor of a geomagnetic-storm effect in stock returns after controlling for market seasonals and other environmental and behavioral factors. Unusually high levels of geomagnetic activity have a negative, statistically and economically significant effect on the following week's stock returns for all U.S. stock market indices. Finally, this paper provides evidence of substantially higher returns around the world during periods of quiet geomagnetic activity.
- Published
- 2003
29. Playing the field: Geomagnetic storms and international stock markets
- Author
-
Anya Krivelyova and Cesare Robotti
- Subjects
Stock market - Abstract
This paper documents the impact of geomagnetic storms (GMS) on world and country-specific stock market returns. For the world index and for most of the international indices in our sample, we find that the previous week's unusually high levels of geomagnetic activity have a negative, statistically and economically significant impact on today's stock returns. Our results are consistent with psychological theories of "misattribution of mood," since GMS have been found to negatively affect people's judgment and behavior.
- Published
- 2003
30. Dynamic Strategies, Asset Pricing Models, and the Out-of-Sample Performance of the Tangency Portfolio
- Author
-
Cesare Robotti
- Subjects
Microeconomics ,Investment theory ,Asset pricing ,Financial markets ,Investments ,Stock market ,Rate of return ,Replicating portfolio ,Consumption-based capital asset pricing model ,Arbitrage pricing theory ,Economics ,Econometrics ,Portfolio ,Capital asset pricing model ,Asset allocation ,Portfolio optimization - Abstract
In this paper, I study the behavior of an investor with unit risk aversion who maximizes a utility function defined over the mean and the variance of a portfolio's return. Conditioning information is accessible without cost and an unconditionally riskless asset is available in the market. ; The proposed approach makes it possible to compare the performance of a benchmark tangency portfolio (formed from the set of unrestricted estimates of portfolio weights) to the performance of a restricted tangency portfolio which uses single-index and multi-index asset pricing models to constrain the first moments of asset returns. ; The main findings of the paper are summarized as follows: i) The estimates of the constant and time-varying tangency portfolio weights are extremely volatile and imprecise. Using an asset pricing model to constrain mean asset returns eliminates extreme short positions in the underlying securities and improves the precision of the estimates of the weights. ii) Partially restricting mean asset returns according to single-index and multi-index asset pricing models improves the out-of-sample performance of the tangency portfolio. iii) Active investment strategies (i.e., strategies that incorporate the role played by conditioning information in investment decisions) strongly dominate passive investment strategies in-sample but do not provide any convincing pattern of improved out-of-sample performance.
- Published
- 2002
31. Asset Returns and Economic Risk
- Author
-
Cesare Robotti
- Subjects
Capital assets pricing model ,Risk - Abstract
The capital asset pricing model (CAPM), favored by financial researchers and practitioners fifteen years ago, holds that the extra return on a risky asset comes from bearing market risk only. But newer evidence supports the intertemporal CAPM (I-CAPM) theory (Merton 1973), which suggests that the premium on any risky asset is related not only to market risk but also to additional economic variables. ; This article reviews and interprets recent advances in the asset pricing literature. The study seeks to shed light on the sources of economic risk that investors should track and hedge against and the sign of the risk premia commanded by economic and financial risks. ; The author empirically measures the impact of prespecified financial and economic variables on the risk-return trade-off by looking at how they affect (or predict) the mean and the variance of asset returns. The analysis shows that variables such as the market portfolio, the term structure, the default premium, and the consumption-aggregate wealth ratio positively affect average asset returns and command positive risk premia while the inflation portfolio negatively affects returns and commands a negative premium. ; The article also provides extensive evidence of time variation in economic risk premia, showing that expected compensation for bearing different sorts of risk is larger at some times and smaller at others depending on economic conditions.
- Published
- 2002
32. Minimum-Variance Kernels, Economic Risk Premia, and Tests of Multi-Beta Models
- Author
-
Pierluigi Balduzzi and Cesare Robotti
- Subjects
Economic risk ,Minimum-variance unbiased estimator ,Actuarial science ,Stochastic discount factor ,Risk premium ,Sharpe ratio ,Econometrics ,Economics ,Capital asset pricing model ,Risk ,Asset pricing ,Econometric models ,Volatility (finance) ,Statistical hypothesis testing - Abstract
This paper uses minimum-variance (MV) admissible kernels to estimate risk premia associated with economic risk variables and to test multi-beta models. Estimating risk premia using MV kernels is appealing because it avoids the need to 1) identify all relevant sources of risk and 2) assume a linear factor model for asset returns. Testing multi-beta models in terms of restricted MV kernels has the advantage that 1) the candidate kernel has the smallest volatility and 2) test statistics are easy to interpret in terms of Sharpe ratios. The authors find that several economic variables command significant risk premia and that the signs of the premia mostly correspond to the effect that these variables have on the risk-return trade-off, consistent with the implications of the intertemporal capital asset pricing model (I-CAPM). They also find that the MV kernel implied by the I-CAPM, while formally rejected by the data, consistently outperforms a pricing kernel based on the size and book-to-market factors of Fama and French (1993).
- Published
- 2001
33. The Price of Inflation and Foreign Exchange Risk in International Equity Markets
- Author
-
Cesare Robotti
- Subjects
Hedging (Finance) ,Asset pricing ,Foreign exchange ,Risk ,Financial economics ,Risk premium ,Sharpe ratio ,Consumption-based capital asset pricing model ,Risk-free interest rate ,Econometrics ,Arbitrage pricing theory ,Economics ,Capital asset pricing model ,Rational pricing ,Security market line - Abstract
This paper uses minimum-variance (MV) admissible kernels to estimate risk premia associated with inflation and foreign exchange risk and to test multi-beta models. Estimating risk premia using MV kernels is appealing because it avoids the need to: i) identify all relevant sources of risk; ii) assume a linear factor model for asset returns. Testing multi-beta models in terms of restricted minimum-variance kernels has the advantage that: i) the candidate kernel has the smallest volatility; ii) test statistics are easy to interpret in terms of Sharpe ratios. I find that only global market risk is significant both conditionally and unconditionally as indicated by the high positive and significant relative Sharpe ratio. When using the Hansen & Jagannathan (1991, 1997) variance bounds and distance measures as testing devices, I find that, while all international asset pricing models are formally rejected by the data, their pricing implications are significantly different. The international intertemporal CAPM in presence of deviations from Purchasing Power Parity (PPP) outperforms all the other asset pricing models.
- Published
- 2001
34. Minimum-Variance Kernels and Economic Risk Premia
- Author
-
Cesare Robotti and Pierluigi Balduzzi
- Abstract
This paper offers a novel way of testing whether prespecified risk variables command significant risk premia. Specifically, we construct portfolios of securities to mimick the variation in the chosen risk variables, and we estimate the conditional and unconditional expected returns on these portfolios in excess of the risk-free rate. We also test for the ability of these hedging portfolios to price the returns on a large collection of assets. Our approach has several advantages over more traditional approachs that model asset returns as linear functions of a given set of explicit factors. First, the risk premia that we estimate do not depend on the appropriate specification of either an asset-pricing model or a stochastic process for asset returns. Second, while we allow for time variation in the conditional risk premia associated with economic risks, our estimates of the unconditional premia do not require explicit modeling of such time variation. Third, we can introduce conditioning information effectively to expand the set of asset returns under scrutiny and improve the ability of the hedging portfolio returns to track the economic risks. Fourth, we are able to impose the no-arbitrage positivity restriction on the pricing kernel, a requirement missing from the standard formulation of multi-beta models.
- Published
- 1999
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