Seminonparametric Estimation of Conditionally Constrained Heterogeneous Processes: Asset Pricing Applications

Abstract

The extent to which specification error can explain rejection of the intertemporal capital asset pricing model is investigated using seminonparametric representations of the law of motion and utility. The authors find (1) consumption growth and asset returns display conditional heterogeneity, but this does not account for rejection of models assuming additively separable, constant relative risk aversion utility; (2) the model is accepted upon relaxation of the utility function in the direction of nonseparable utility; and (3) relaxation reduces overprediction of the conditional variance of consumption growth, overprediction of the conditional covariance of asset returns with consumption growth, and the equity premium. Copyright 1989 by The Econometric Society.