Journal of Financial Economics Journal of Financial Economics

Abstract

Abstract We propose a new method of testing asset pricing models that relies on quantities rather than just prices or returns. We use the capital flows into and out of mutual funds to infer which risk model investors use. We derive a simple test statistic that allows us to infer, from a set of candidate models, the risk model that is closest to the model that investors use in making their capital allocation decisions. Using our method, we assess the performance of the most commonly used asset pricing models in the literature. Abstract We propose a new method of testing asset pricing models that relies on using quantities rather than simply prices or returns. We use the capital flows into and out of mutual funds to infer which risk model investors use. We derive a simple test statistic that allows us to infer, from a set of candidate models, the model that is closest to the model that investors use in making their capital allocation decisions. Using our method, we assess the performance of the most commonly used asset pricing models in the literature. ∗ Forthcoming, Journal of Financial Economics . We are grateful to the referee for his especially clear and insightful comments. We are grateful to John Cochrane, George Constantinides, Peter DeMarzo, Wayne Ferson, Ravi Jagannathan, Valentine Haddad, Lars Hansen, John Heaton, Binying Lui, Tim McQuade, Lubos Pastor, Paul Pfleiderer, Monika Piazzesi, Anamaria Pieschacon, Martin Schneider, Ken Singleton, Rob Stambaugh, and seminar participants at the 2015 AFA meetings, Harvard, the Kellogg Junior Finance Conference, Notre Dame, Princeton University, Stanford GSB, the Stanford Institute for Theoretical Economics (SITE), the University of Chicago, University of Washington Summer Finance Conference and Washington University in St. Louis for their comments and suggestions.