What Is the Consumption-CAPM Missing? An Information-Theoretic Framework for the Analysis of Asset Pricing Models
Authors:ÌýAnisha Ghosh, Christian Julliard, Alex P. Taylor
Publication:ÌýThe Review of Financial Studies, Volume 30, No. 2, February 2017
Abstract:Ìý
We consider asset pricing models in which the SDF can be factorized into an observable component and a potentially unobservable one. Using a relative entropy minimization approach, we nonparametrically estimate the SDF and its components. Empirically, we find the SDF has a business-cycle pattern and significant correlations with market crashes and the Fama-French factors. Moreover, we derive novel bounds for the SDF that are tighter and have higher information content than existing ones. We show that commonly used consumption-based SDFs correlate poorly with the estimated one, require high risk aversion to satisfy the bounds and understate market crash risk.
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