6.7 Conclusion and Implication

In the empirical part of this chapter, we studied three major issues. The first issue is whether using different attributes to sort stocks into portfolios affects asset pricing inference. It is found that portfolios formed from different attributes can lead to contradictory inference in the same model specification. For example, with equally weighted excess market return and size factor return as explanatory variables, the beta-sorted portfolios and the size-sorted portfolios give inconsistent results from 1985 to 2000. The second issue is about whether the use of individual assets can solve the problem of grouping. It is found that the disturbances of individual assets are correlated, which violates the central assumption of the average F test. Also, the poor fit of individual assets suggests that the average F test has poor power. The final issue examined is whether different asset pricing tests give the same inference. It is found that the multivariate F test, the average F test and the robust specification test can give different inference for the same specification. It is because the definition of pricing errors and the weighting matrix used are different for the three tests.

The simulation study of this chapter examines how robust are the asset pricing tests to spurious correlation between sorting attribute and estimation error. In both scenarios examined, it is found that the average F test is most prone to the spurious correlation of the three tests we examined. Also, another finding is that the...