A Rehabilitation of Stochastic Discount Factor Methodology / John H. Cochrane.

Format:

Book

Author/Creator:

Cochrane, John H.

Contributor:

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8533.

NBER working paper series no. w8533

Language:

English

Subjects (All):

Stocks--Prices.

Stocks.

Capital assets pricing model.

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2001.

Cambridge, Massachusetts : National Bureau of Economic Research, 2001.

Summary:

In a recent Journal of Finance article, Kan and Zhou (1999) find that the 'Stochastic discount factor' methodology using GMM is markedly inferior to traditional maximum likelihood even in a simple test of the static CAPM with i.i.d. normal returns. This result has gained wide attention. However, as Jagannathan and Wang (2001) point out, this result flows from a strange assumption: Kan and Zhou allow the ML estimate to know the mean market return ex-ante. I show how this information advantage explains Kan and Zhou's results. In fact, when treated symmetrically, the discount factor - GMM and traditional methodologies behave almost identically in linear i.i.d. environments.

Notes:

Print version record

October 2001.