Bossaerts, Peter (2004) Filtering returns for unspecified biases in priors when testing asset pricing theory. Review of Economic Studies, 71 (1). pp. 63-86. ISSN 0034-6527 http://resolver.caltech.edu/CaltechAUTHORS:BOSres04
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Procedures are presented that allow the empiricist to estimate and test asset pricing models on limited-liability securities without the assumption that the historical payoff distribution provides a consistent estimate of the market's prior beliefs. The procedures effectively filter return data for unspecified historical biases in the market's priors. They do not involve explicit estimation of the market's priors, and hence, economize on parameters. The procedures derive from a new but simple property of Bayesian learning, namely: if the correct likelihood is used, the inverse posterior at the true parameter value forms a martingale process relative to the learner's information filtration augmented with the true parameter value. Application of this central result to tests of asset pricing models requires a deliberate selection bias. Hence, as a by-product, the article establishes that biased samples contain information with which to falsify an asset pricing model or estimate its parameters. These include samples subject to, e.g. survivorship bias or Peso problems.
|Additional Information:||© 2004 The Review of Economic Studies Limited. First version received July 1999; final version accepted April 2002. The reader who is interested in a verbose version of this paper, with extensive numerical examples, is referred to Bossaerts (1998). The first part of this paper came out of a sketchy set of notes that the author presented at the Universite des Sciences Sociales, Toulouse, in April 1995, while he was at CentER, Tilburg University. He is grateful for the many comments from the seminar participants. In addition, the paper benefited through discussions at seminars at Carnegie Mellon University, U.C. Berkeley, U.C.L.A., U.C. Riverside, University of Minnesota, Washington University at Saint Louis, the 1996 Asset Pricing summer meeting at NBER, the 1996 European Meetings of the Econometric Society, the 1998 CEPR Meetings in Gerzensee, and through comments from and discussions with Oleg Bondarenko, James Dow, Darrell Duffie, David Easley, Ravi Jagannathan, Pierre Hillion, Alan Kraus, Guy Laroque, P.C.B. Phillips, Richard Roll, Philippe Weil and three anonymous referees. Oleg Bondarenko provided able research assistance. The usual disclaimer applies.|
|Subject Keywords:||EFFICIENT CAPITAL-MARKETS; EXPECTATIONS|
|Usage Policy:||No commercial reproduction, distribution, display or performance rights in this work are provided.|
|Deposited By:||Lindsay Cleary|
|Deposited On:||04 Oct 2006|
|Last Modified:||26 Dec 2012 09:04|
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