On Robust Inference for Consumption-based Asset Pricing

Abstract

Kleibergen and Zhan (Robust Inference for Consumption-based Asset Pricing, Journal of Finance, 2020) propose a new approach to test consumption-based asset pricing models that is robust to the useless factor problem, i.e. concluding that a factor is priced when the factor is actually uncorrelated with the test assets. They find that recently proposed factors do not pass their test, which they attribute to a lack of factor correlation with the test assets. This conclusion is odd, as the factor correlation is significant and economically large, often 0.40 and above. Instead, I show that their testing approach lacks power in small samples. I propose simple remedies that help to achieve robust consumption-based asset pricing that comes with power.