Empirical Evaluation of Asset Pricing Models: Arbitrage and Pricing Errors in Contingent Claims
39 Pages Posted: 18 Mar 2008 Last revised: 14 May 2014
Date Written: November 1, 2011
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 dis- count factors are often negative and admit arbitrage opportunities.
Keywords: asset pricing, arbitrage, contingent claims
JEL Classification: G1, G12
Suggested Citation: Suggested Citation
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