Empirical tests of asset pricing models with individual assets: Resolving the errors-in-variables bias in risk premium estimation

Narasimhan Jegadeesh; Joonki Noh; Kuntara Pukthuanthong; Richard Roll; Junbo Wang

doi:10.1016/j.jfineco.2019.02.010

Journal of Financial Economics Vol. 133 No. 2 2019

Empirical tests of asset pricing models with individual assets: Resolving the errors-in-variables bias in risk premium estimation

Narasimhan Jegadeesh¹; Joonki Noh²; Kuntara Pukthuanthong^3,4; Richard Roll^5,6; Junbo Wang⁷

¹ Emory University · ² Case Western Reserve University · ³ University of Missouri · ⁴ Cornell University · ⁵ Baxter (United States) · ⁶ California Institute of Technology · ⁷ Louisiana State University

open access

Abstract

To attenuate an inherent errors-in-variables bias, portfolios are widely employed to test asset pricing models; but portfolios might mask relevant risk- or return-related features of individual stocks. We propose an instrumental variables approach that allows the use of individual stocks as test assets, yet delivers consistent estimates of ex post risk premiums. This estimator also yields well-specified tests in small samples. The market risk premium under the capital asset pricing model (CAPM) and the liquidity-adjusted CAPM, premiums on risk factors under the Fama–French three- and five-factor models, and the Hou et al. (2015) four-factor model are all insignificant after controlling for asset characteristics.

DOI: 10.1016/j.jfineco.2019.02.010
Volume: 133
Issue: 2
Pages: 273-298
Language: en
Sources: bibtex:phds-export.bib openalex crossref

Empirical tests of asset pricing models with individual assets: Resolving the errors-in-variables bias in risk premium estimation

Abstract

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