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Working Paper 1995-018A

"Testing Asset Pricing Models with Euler Equations: It's Far Worse Than You Think. Original version, 94-010A"
by Christopher J. Neely

This paper reexamines the small sample properties of Hansen?s (1982) Generalized Method of Moments (GMM) and Hansen and Jagannathan?s (1989) estimation-free tests on simulated data from a more plausible consumption based asset pricing model. Previous studies are incomplete and misleading. A continuous distribution of consumption growth produces a near nonidentification in the GMM criterion function, severe bias in coefficient estimates, misleading parameter confidence intervals even for very large samples and far worse overrejection problem in GMM tests of restriction than previously thought. Further, estimation-free methods advocated by Kocherlakota (1990) may also have very poor finite sample properties.

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Category > Applied Econometrics
Category > Finance
Author > Christopher J. Neely
Research Papers and Publications: JEL Code > C1
Research Papers and Publications: JEL Code > E1