GMM Weighting Matrices in Cross-Sectional Asset Pricing Tests

58 Pages Posted: 21 Nov 2017 Last revised: 29 Jun 2021

See all articles by Nora Laurinaityte

Nora Laurinaityte

Bank of Lithuania

Christoph Meinerding

Deutsche Bundesbank

Christian Schlag

Goethe University Frankfurt; Leibniz Institute for Financial Research SAFE

Julian Thimme

Karlsruhe Institute of Technology

Date Written: June 09, 2021

Abstract

Cross-sectional asset pricing tests with GMM can generate spuriously high explanatory power when the estimated factor means are allowed to deviate substantially from the sample averages. In fact, by shifting the weights on the moment conditions, any level of cross-sectional t can be attained. The mathematically correct global minimum of the GMM objective function can be obtained at a parameter vector that is far away from the true parameters of the data-generating process. This property is a feature of the GMM estimation design and applies to strong as well as weak factors, and to all sample sizes and test assets.

Keywords: Asset pricing, cross-section of expected returns

JEL Classification: G00, G12, C21, C13

Suggested Citation

Laurinaityte, Nora and Meinerding, Christoph and Schlag, Christian and Thimme, Julian, GMM Weighting Matrices in Cross-Sectional Asset Pricing Tests (June 09, 2021). Available at SSRN: https://ssrn.com/abstract=3073197 or http://dx.doi.org/10.2139/ssrn.3073197

Nora Laurinaityte

Bank of Lithuania ( email )

Totoriu 4
Vilnius, LT-01121
Lithuania

Christoph Meinerding (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Christian Schlag

Goethe University Frankfurt ( email )

Faculty of Economics and Business
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60323
Germany

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)

Julian Thimme

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

HOME PAGE: http://www.julianthimme.de

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