Econometrica: Sep 2017, Volume 85, Issue 5

Spurious Inference in Reduced-Rank Asset-Pricing Models

DOI: 10.3982/ECTA13750
p. 1613-1628

Nikolay Gospodinov, Raymond Kan, Cesare Robotti

This note studies some seemingly anomalous results that arise in possibly misspecified, reduced‐rank linear asset‐pricing models estimated by the continuously updated generalized method of moments. When a spurious factor (that is, a factor that is uncorrelated with the returns on the test assets) is present, the test for correct model specification has 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. The rejection probability of the test for overidentifying restrictions typically decreases further in underidentified models where the dimension of the null space is larger than 1.

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Supplemental Material

Supplement to "Spurious Inference in Reduced-Rank Asset-Pricing Models"

This Supplemental Material is structured as follows. Section 1 establishes the equivalence of the CU-GMM estimators with centered and uncentered optimal weighting matrices and serially correlated moment conditions. Section 2 shows that the result in Theorem 2 in the paper continues to hold under the assumption that the returns and the factors are jointly elliptically distributed.

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Supplement to "Spurious Inference in Reduced-Rank Asset-Pricing Models"

This zip file contains the replication files for the manuscript.

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