On Comparing Asset Pricing Models |
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| Authors: | SIDDHARTHA CHIB XIAMING ZENG LINGXIAO ZHAO |
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| Institution: | 1. Siddhartha Chib is at the Olin Business School, Washington University in St. Louis. Xiaming Zeng is an Investment Professional. Lingxiao Zhao is at the Department of Economics, Washington University in St. Louis. We are grateful to the Editor (Stefan Nagel) and two anonymous reviewers for their constructive and helpful comments. We have read The Journal of Finance disclosure policy and have no conflicts of interest to 2. disclose. |
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| Abstract: | Revisiting the framework of (Barillas, Francisco, and Jay Shanken, 2018, Comparing asset pricing models, The Journal of Finance 73, 715–754). BS henceforth, we show that the Bayesian marginal likelihood-based model comparison method in that paper is unsound : the priors on the nuisance parameters across models must satisfy a change of variable property for densities that is violated by the Jeffreys priors used in the BS method. Extensive simulation exercises confirm that the BS method performs unsatisfactorily. We derive a new class of improper priors on the nuisance parameters, starting from a single improper prior, which leads to valid marginal likelihoods and model comparisons. The performance of our marginal likelihoods is significantly better, allowing for reliable Bayesian work on which factors are risk factors in asset pricing models. |
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