Title: Asset-pricing models and economic risk premia
Description: "The risk premia assigned to economic (nontraded) risk factors can be decomposed into three  parts: (i) the risk premia on maximum-correlation portfolios mimicking the factors; (ii) (minus) the  covariance between the nontraded components of the candidate pricing kernel of a given model and the  factors; and (iii) (minus) the mispricing assigned by the candidate pricing kernel to the maximumcorrelation  mimicking portfolios. The first component is the same across asset-pricing models and is  typically estimated with little (absolute) bias and high precision. The second component, on the other  hand, is essentially arbitrary and can be estimated with large (absolute) biases and low precisions by  multi-beta models with nontraded factors. This second component is also sensitive to the criterion  minimized in estimation. The third component is estimated reasonably well, both for models with traded  and nontraded factors. We conclude that the economic risk premia assigned by multi-beta models with  nontraded factors can be very unreliable. Conversely, the risk premia on maximum-correlation portfolios  provide more reliable indications of whether a nontraded risk factor is priced. These results hold for both  the constant and the time-varying components of the factor risk premia."--Federal Reserve Bank of Atlanta web site.
Subjects: Capital assets pricing model, Mathematical models