GMM Weighting Matrices in Cross-Sectional Asset Pricing Tests
58 Pages Posted: 21 Nov 2017 Last revised: 29 Jun 2021
Date Written: June 09, 2021
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: Suggested Citation