C Hausse

Outline
GMM in finance
GMM with R
GEL in finance
Whats next?
GMM and GEL with R
Pierre Chauss1
UQM and CIRPE
Rmetrics Workshop 2009
1
Special thanks to Rmetrics Association and its partners for financial
support.
Pierre Chauss GMM and GEL with R
Outline
GMM in finance
GMM with R
GEL in finance
Whats next?
1 GMM in finance
The generalized method of moments
Consumption-CAPM
Linear factor pricing models
Nonlinear factor models
Continuous time processes
2 GMM with R
The function gmm()
Linear models
Nonlinear models
3 GEL in finance
The generalized empirical likelihood
GEL with R
4 Whats next?
Outline The generalized method of moments
GMM in finance Consumption-CAPM
GMM with R Linear factor pricing models
GEL in finance Nonlinear factor models
Whats next? Continuous time processes
Articles on which this presentation is based:
Chauss(2009), "Computing Generalized Empirical

Likelihood and Generalized Method of Moments with R"
Jagannathan, Skoulakis and Wang(2002), "Generalized

Method of Moments: Applications in Finance", JBES
Cochrane(2001), "Asset Pricing", Princeton University

Press
GMM
We want to estimate the vector of parameters 0 Rp based on

either h i
E g(0 , xt ) = 0
or h i
E g(0 , xt )|It = 0,
where g() is a q 1 vector of moment conditions, with q p,

and It is an information set. The conditional moment conditions
can be replaced by the following unconditional moment
conditions: h i
E g(0 , xt )f (zt ) = 0,
where zt It and f () is any function.

GMM

either h i
E g(0 , xt ) = 0
or h i
E g(0 , xt )|It = 0,

conditions: h i
E g(0 , xt )f (zt ) = 0,

GMM

either h i
E g(0 , xt ) = 0
or h i
E g(0 , xt )|It = 0,

conditions: h i
E g(0 , xt )f (zt ) = 0,

GMM: The estimator

The GMM estimator is defined as
= arg min g() W g(),

where
T
1X
g() = g(, xt )
T
t=1
The asymptotic efficiency is achieved if the matrix W is the
inverse
of a consistent estimate of the covariance matrix of
T g() defined as:

X
() = Cov[g(, xt ), g(, xt+s )]
s=

GMM: The estimator

The GMM estimator is defined as
= arg min g() W g(),

where
T
1X
g() = g(, xt )
T
t=1
The asymptotic efficiency is achieved if the matrix W is the
inverse
of a consistent estimate of the covariance matrix of
T g() defined as:

X
() = Cov[g(, xt ), g(, xt+s )]
s=

GMM: The HAC estimator

() is estimated by the following heteroskedasticity and
autocorrelation consistent estimator (HAC):
T
X 1
( ) = kh (s)s ( )
s=(T 1)
where, kh (s) is a kernel, h is the bandwidth which can be

chosen using a procedure such as the ones proposed by
Newey-West(1987a) or Andrews(1991),
1X
s ( ) = g( , xt )g( , xt+s )
T
t
and is a convergent estimate of 0 .

GMM: The three methods
Two step GMM (Hansen (1982))

1) = arg min g() g()
2) = arg min g() ( )1 g()
Iterated GMM (Hansen-Eaton-Yaron (1996))
1) (1) = arg min g() g()
2) (2) = arg min g() ((1) )1 g()
3) (1) = arg min g() ((2) )1 g() and go back to 2) until
convergence.
Continuous updated GMM (Hansen-Eaton-Yaron (1996))
= arg min g() ()1 g()



2) = arg min g() ( )1 g()
1) (1) = arg min g() g()
2) (2) = arg min g() ((1) )1 g()
convergence.
= arg min g() ()1 g()



2) = arg min g() ( )1 g()
1) (1) = arg min g() g()
2) (2) = arg min g() ((1) )1 g()
convergence.
= arg min g() ()1 g()


GMM: Properties
Given some regularity conditions, the GMM estimator
converges as T goes to infinity to the following distribution:
L
T ( 0 ) N(0, V ),
where

g(0 , xt ) g(0 , xt )
V =E (0 )1 E

Finally, we can test the (q p) overidentifying restrictions using
the result that, under the null H0 : E [g(, xt )] = 0:
L
T g() [( )]1 g() 2qp

GMM: Properties
Given some regularity conditions, the GMM estimator
converges as T goes to infinity to the following distribution:
L
T ( 0 ) N(0, V ),
where

g(0 , xt ) g(0 , xt )
V =E (0 )1 E

Finally, we can test the (q p) overidentifying restrictions using
the result that, under the null H0 : E [g(, xt )] = 0:
L
T g() [( )]1 g() 2qp

C-CAPM
The micro-foundations of the pricing equation:
E (mt+1 Ri,t+1 |It ) = 1 for i = 1, ..., N,
where Ri,t is the gross return of asset i and mt+1 is the

stochastic discount factor, are based on the maximization of the
expected present value of the lifetime utility of a representative
investor.
This problem results in the following moment conditions

U (Ct+1 )
E Ri,t+1 It = 1
U (Ct )

C-CAPM
The micro-foundations of the pricing equation:
E (mt+1 Ri,t+1 |It ) = 1 for i = 1, ..., N,
where Ri,t is the gross return of asset i and mt+1 is the

stochastic discount factor, are based on the maximization of the
expected present value of the lifetime utility of a representative
investor.
This problem results in the following moment conditions

U (Ct+1 )
E Ri,t+1 It = 1
U (Ct )

C-CAPM
If the utility is given by the popular constant relative risk
aversion function
1
z /(1 ) if 6= 1
U(z) = ,
log z if = 1
The moment conditions become:

" #
C t+1
1
E
Ct = 0 for i = 1, ..., N
Ri,t+1 zt

| {z }
g(,xt )
where zt It .
CAPM
The CAPM implies the following relations:
E (Rit ) Rf = i [E (Rm,t ) Rf ] for i = 1, ..., N
which can be tested using the following regression:
Rit Rf = i + i (Rm,t Rf ) + it for i = 1, ..., N
It can be estimated by GMM using:

1
g(, xt ) = t
(Rm,t Rf )
where t = {1t , ..., Nt } and is the Kronecker product.

CAPM

1
g(, xt ) = t
(Rm,t Rf )

CAPM

1
g(, xt ) = t
(Rm,t Rf )

CAPM
The restricted regression:
Rit Rf = i (Rm,t Rf ) + it for i = 1, ..., N
allows the testing of the theory through the J-Test of

overidentifying restrictions (2N conditions, N coefficients to
estimate).

CAPM-Black
In the Black version, Rf does not exist and is replaced by , the

expected return of the zero-beta. The model implies:
Rit = + i (Rm,t ) + it
The moment conditions are:

1
E t =0
(Rm,t Rf )
There are 2N conditions and N + 1 parameters. The test of

overidentifying restrictions can be used to test the theory.

Factor models: SDF representation

We can test the pricing conditions:
E (mRi ) = 1 for i = 1, ..., N
using the stochastic discount factor m implied by the factor
models as shown by Hansen and Richard(1987). For the
CAPM, the discount factor is mt = 0 + 1 Rmt . The moment
conditions become:
h i
E Rit (0 1 Rmt ) 1 = 0 for i = 1, ..., N
For the multi-factor model, the SDF is:

k
X
mt = 0 + s fst
s=1

Factor models: SDF representation

We can test the pricing conditions:
E (mRi ) = 1 for i = 1, ..., N
using the stochastic discount factor m implied by the factor
models as shown by Hansen and Richard(1987). For the
CAPM, the discount factor is mt = 0 + 1 Rmt . The moment
conditions become:
h i
E Rit (0 1 Rmt ) 1 = 0 for i = 1, ..., N
For the multi-factor model, the SDF is:

k
X
mt = 0 + s fst
s=1

Nonlinear factor models: SDF representation

Based on some assumptions on the investors preference,
Bansal and Viswanathan(1993) propose the following SDF
(single factor model):
k
X
mt = 0 + 1 rf + s (rmt rf )s
s=1
Bansal, Hsieh, and Viswanathan(1993) propose a modification
of the previous study with an SDK based on a neural network
approach:
k
X
mt = 0 + 1 rf + s h(0s + 1s rmt )
s=1
ex
with h(x) = ex +1
Discrete time approximations

Several continuous time processes for the term structure of
interest rate is embedded in the following process:
drt = ( + rt )dt + rt dWt
= 0 and = 0: Brownian motion with drift

= 0: Ornstein-Uhlenbeck process
= 1/2: Cox-Ingersoll-Ross process.
The discrete approximation is:
rt+1 rt = + rt + t+1
with
Et t+1 = 0, and Et (2t+1 ) = 2 rt2


Several continuous time processes for the term structure of
interest rate is embedded in the following process:
drt = ( + rt )dt + rt dWt
= 0 and = 0: Brownian motion with drift

= 0: Ornstein-Uhlenbeck process
= 1/2: Cox-Ingersoll-Ross process.
The discrete approximation is:
rt+1 rt = + rt + t+1
with
Et t+1 = 0, and Et (2t+1 ) = 2 rt2

Notice: Maximum likelihood cannot be used because the

distribution depends on : It is normal for = 0 and gamma for
= 1/2.
The moment conditions for the GMM approach are:

t+1

t+1 rt

E [g(, xt )] E 2 =0
2t+1 2 rt
(2t+1 2 rt2 )rt
Other moment conditions could be added by using variables

from the information set It

Notice: Maximum likelihood cannot be used because the

distribution depends on : It is normal for = 0 and gamma for
= 1/2.
The moment conditions for the GMM approach are:

t+1

t+1 rt

E [g(, xt )] E 2 =0
2t+1 2 rt
(2t+1 2 rt2 )rt
Other moment conditions could be added by using variables

from the information set It

Without discrete time approximation

The following approach is proposed by Hansen and
Scheinkman (1995). We want to estimate:
drt = (rt )dt + (rt )dWt
It is based on the assumption that rt is stationary which implies
E ((rt )) = c for some smooth functions ().
Then, after some manipulations (integrating, using Itos lemma
and Fubinis theorem), we can obtain the following moment
conditions:

1
E (rt ) (rt ) + (rt ) (rt ) = 0
2
For more efficiency, more moment conditions can be derived
using informations from the conditional distribution as well (see
Chan, Karolyi, Longstaff and Sanders (1992)).

conditions:

1
E (rt ) (rt ) + (rt ) (rt ) = 0
2

conditions:

1
E (rt ) (rt ) + (rt ) (rt ) = 0
2
Outline
GMM in finance The function gmm()
GMM with R Linear models
GEL in finance Nonlinear models
Whats next?
gmm()
gmm(g,x,t0=NULL,gradv=NULL,
type=c("twoStep","cue","iterative")
Other important options:
wmatrix = c("optimal","ident")
vcov=c("HAC","iid")
kernel=c("Quadratic Spectral","Truncated", "Bartlett",
"Parzen", "Tukey-Hanning")
bw = bwAndrews2 or bwNeweyWest2

Outline
Whats next?
gmm()
vcov=c("HAC","iid")

Outline
Whats next?
gmm()
vcov=c("HAC","iid")

Outline
Whats next?
gmm()
vcov=c("HAC","iid")

Outline
Whats next?
gmm()
vcov=c("HAC","iid")

Outline
Whats next?
The CAPM: estimation
> require(gmm)
> data(Finance)
> r <- Finance$r[1:300, ]
> rm <- Finance$rm[1:300]
> rf <- Finance$rf[1:300]
> z <- r - rf
> t <- nrow(z)
> zm <- matrix(rm - rf, t, 1)
> res <- gmm(z ~ zm, x = zm)
The model is zt = + zmt + t , the instruments are (1, zmt ).

Outline
Whats next?
The CAPM: the object of class gmm
The object "res" is a list:

> matrix(names(res), 3, 3)
[,1] [,2] [,3]

[1,] "par" "gt" "n"
[2,] "objective" "df" "met"
[3,] "vcov" "k" "kernel"
The parameters keep the names of the variables

> c(res$par)
WMK_(Intercept) UIS_(Intercept) ORB_(Intercept) MAT_(Intercept)

-0.004669736 0.102346762 0.145874663 0.035895010
ABAX_(Intercept) T_(Intercept) EMR_(Intercept) JCS_(Intercept)
0.091742457 0.023103455 0.029928596 0.116804715
VOXX_(Intercept) ZOOM_(Intercept) WMK_zm UIS_zm
0.020871224 -0.219135356 0.317193344 1.262716102
ORB_zm MAT_zm ABAX_zm T_zm
1.493908805 1.014990227 1.088976989 0.848978815
EMR_zm JCS_zm VOXX_zm ZOOM_zm
0.740787592 0.958818772 1.482166171 2.077703465

Outline
Whats next?
The CAPM: the object of class gmm
The object "res" is a list:

> matrix(names(res), 3, 3)
[,1] [,2] [,3]

[1,] "par" "gt" "n"
[2,] "objective" "df" "met"
[3,] "vcov" "k" "kernel"
The parameters keep the names of the variables

> c(res$par)
WMK_(Intercept) UIS_(Intercept) ORB_(Intercept) MAT_(Intercept)

-0.004669736 0.102346762 0.145874663 0.035895010
ABAX_(Intercept) T_(Intercept) EMR_(Intercept) JCS_(Intercept)
0.091742457 0.023103455 0.029928596 0.116804715
VOXX_(Intercept) ZOOM_(Intercept) WMK_zm UIS_zm
0.020871224 -0.219135356 0.317193344 1.262716102
ORB_zm MAT_zm ABAX_zm T_zm
1.493908805 1.014990227 1.088976989 0.848978815
EMR_zm JCS_zm VOXX_zm ZOOM_zm
0.740787592 0.958818772 1.482166171 2.077703465

Outline
Whats next?
The CAPM: the summary() method

The summary() method produces the following results:
> names(summary(res))
[1] "met" "kernel" "algo" "par" "J_test" "j"
The $par argument of summary() is more detailed:
> summary(res)$par
Estimate Std. Error t value Pr(>|t|)
WMK_(Intercept) -0.00467 0.05748 -0.08123 0.93526
UIS_(Intercept) 0.10235 0.11846 0.86401 0.38758
ORB_(Intercept) 0.14587 0.21227 0.68721 0.49195
MAT_(Intercept) 0.03590 0.10609 0.33833 0.73511
ABAX_(Intercept) 0.09174 0.27258 0.33657 0.73644
T_(Intercept) 0.02310 0.07582 0.30471 0.76059
EMR_(Intercept) 0.02993 0.05477 0.54641 0.58478
JCS_(Intercept) 0.11680 0.16275 0.71768 0.47296
VOXX_(Intercept) 0.02087 0.17444 0.11965 0.90476
ZOOM_(Intercept) -0.21914 0.19673 -1.11391 0.26532
WMK_zm 0.31719 0.13076 2.42575 0.01528
UIS_zm 1.26272 0.22784 5.54211 0.00000
ORB_zm 1.49391 0.42138 3.54524 0.00039
MAT_zm 1.01499 0.22899 4.43253 0.00001
ABAX_zm 1.08898 0.57801 1.88401 0.05956
T_zm 0.84898 0.16218 5.23482 0.00000
EMR_zm 0.74079 0.10460 7.08231 0.00000
JCS_zm 0.95882 0.35882 2.67213 0.00754
VOXX_zm 1.48217 0.38027 3.89762 0.00010
ZOOM_zm 2.07770 0.31617 6.57140 0.00000
Outline
Whats next?
The CAPM: the summary() method
The J-test of overidentifying restrictions

> summary(res)$j
J-test Pz(>j)
Test E(g)=0: 1.53759618288292e-29 *******

Outline
Whats next?
The CAPM: testing the model
First, we can use the function lintest() to test the null:
H0 : R = c
where = {, } , R = {IN , ONN } and c = 0N1 .

Outline
Whats next?
> R <- cbind(diag(10), matrix(0, 10, 10))

> c <- matrix(0, 10, 1)
> lintest(res, R, c)
[[1]]
[1] "Wald test for H0: R(Theta)=c"
$H0
Null Hypothesis
[1,] WMK_(Intercept) = 0
[2,] UIS_(Intercept) = 0
[3,] ORB_(Intercept) = 0
[4,] MAT_(Intercept) = 0
[5,] ABAX_(Intercept) = 0
[6,] T_(Intercept) = 0
[7,] EMR_(Intercept) = 0
[8,] JCS_(Intercept) = 0
[9,] VOXX_(Intercept) = 0
[10,] ZOOM_(Intercept) = 0
$result
Statistics P-Value
Wald test 4.118292 0.9418528

Outline
Whats next?
Second, we use the J-test on the constraint model

> h <- cbind(1, zm)
> res_c <- gmm(z ~ zm, x = h, intercept = FALSE)
> summary(res_c)$j
J-test Pz(>j)
Test E(g)=0: 3.984548 0.9480414

Outline
Whats next?
The APT of Fama-French
Using the three-factor model of Fama and French:

> hml <- Finance$hml[1:300]
> smb <- Finance$smb[1:300]
> h <- cbind(1, zm, hml, smb)
> res_apt <- gmm(z ~ zm + hml + smb, x = h, intercept = FALSE)
> summary(res_apt)$j
J-test Pz(>j)
Test E(g)=0: 2.818007 0.9853883

Outline
Whats next?
The Black-CAPM
The moment function is like the CAPM but with:
t = rt (rmt )
where is the expected return of the zero-beta portfolio (here,

= {, } ).
> g <- function(theta, x) {
+ e <- x[, 2:11] - theta[1] - (x[, 1] - theta[1]) %*% matrix(theta[2:11],
+ 1, 10)
+ gmat <- cbind(e, e * c(x[, 1]))
+ return(gmat)
+ }
> x <- cbind(rm, r)
> res <- gmm(g, x = x, rep(0, 11))

Outline
Whats next?
The Black-CAPM
> summary(res)$par

Theta[1] 0.09463 0.07084 1.33595 0.18156
Theta[2] 0.40077 0.12702 3.15521 0.00160
Theta[3] 1.02717 0.23039 4.45845 0.00001
Theta[4] 1.00463 0.42721 2.35158 0.01869
Theta[5] 0.83611 0.22523 3.71217 0.00021
Theta[6] 0.65384 0.54010 1.21060 0.22605
Theta[7] 0.79805 0.15163 5.26318 0.00000
Theta[8] 0.80353 0.10048 7.99680 0.00000
Theta[9] 0.92048 0.34594 2.66083 0.00779
Theta[10] 1.32823 0.36145 3.67476 0.00024
Theta[11] 2.11812 0.30396 6.96839 0.00000
> summary(res)$j
J-test Pz(>j)
Test E(g)=0: 5.801583 0.7596007

Outline
Whats next?
The CAPM (SDF): testing the model
Here we need to compute a T q matrix with typical

element (t, i) equals to gi (, xt ) = (0 + 1 Rmt )Rit 1:
> g <- function(tet, x) {
+ gmat <- (tet[1] + tet[2] * (1 + c(x[, 1]))) * (1 + x[, 2:11]) -
+ 1
+ return(gmat)
+ }
> res_sdf <- gmm(g, x = cbind(rm, r), c(0, 0))
> summary(res_sdf)$j
J-test Pz(>j)
Test E(g)=0: 3.824509 0.8725995

Outline
Whats next?
The CAPM (SDF): testing the model
To improve precision, we can provide the derivative of g():

P P
Dg = T1 t Rt , T1 t Rt Rmt
> Dg <- function(tet, x) {

+ G <- cbind(colMeans(1 + x[, 2:11]), colMeans(c(1 + x[, 1]) *
+ (1 + x[, 2:11])))
+ return(G)
+ }
> res_sdf <- gmm(g, x = cbind(rm, r), c(0, 0), gradv = Dg)

Outline
Whats next?
Discrete time approximation of continuous time

processes
As shown above, we need to write a function which returns

a T 4 matrix with the t th row equals:

t+1

t+1 rt

g(, xt ) = 2
2t+1 2 rt

(2t+1 2 rt2 )rt
where
t+1 = rt+1 rt rt

Outline
Whats next?

processes
In the function, = {, , 2 , }
+ t <- length(x)
+ et1 <- diff(x) - theta[1] - theta[2] * x[-t]
+ ht <- et1^2 - theta[3] * x[-t]^(2 * theta[4])
+ g <- cbind(et1, et1 * x[-t], ht, ht * x[-t])
+ return(g)
+ }
> rf <- Finance$rf

> rf <- ((1 + rf/100)^(365) - 1) * 100
> dr <- diff(rf)
> res_0 <- lm(dr ~ rf[-length(rf)])
> tet0 <- c(res_0$coef, var(residuals(res_0)), 0)
> res_rf <- gmm(g, rf, tet0, control = list(maxit = 1000, reltol = 1e-10))
> summary(res_rf)$par

Theta[1] 0.01067 0.00469 2.27769 0.02274
Theta[2] -0.00207 0.00104 -1.98885 0.04672
Theta[3] 0.00649 0.00335 1.93711 0.05273
Theta[4] 0.45948 0.15987 2.87410 0.00405

Outline
Whats next?

processes
In the function, = {, , 2 , }
+ t <- length(x)
+ et1 <- diff(x) - theta[1] - theta[2] * x[-t]
+ ht <- et1^2 - theta[3] * x[-t]^(2 * theta[4])
+ g <- cbind(et1, et1 * x[-t], ht, ht * x[-t])
+ return(g)
+ }
> rf <- Finance$rf

> rf <- ((1 + rf/100)^(365) - 1) * 100
> dr <- diff(rf)
> res_0 <- lm(dr ~ rf[-length(rf)])
> tet0 <- c(res_0$coef, var(residuals(res_0)), 0)
> res_rf <- gmm(g, rf, tet0, control = list(maxit = 1000, reltol = 1e-10))
> summary(res_rf)$par

Theta[1] 0.01067 0.00469 2.27769 0.02274
Theta[2] -0.00207 0.00104 -1.98885 0.04672
Theta[3] 0.00649 0.00335 1.93711 0.05273
Theta[4] 0.45948 0.15987 2.87410 0.00405

Outline
GMM in finance
GMM with R
GEL with R
GEL in finance
Whats next?
GEL
First of all, we need to smooth the moment function in order to
take into account the autocorrelation and conditional
heteroskedasticity. g(, xt ) is replaced by:
m
X
g w (, xt ) = w (s)g(, xts )
s=m
where w (s) are kernel based weights that sum to one. The
sample moment conditions become:
T
X
g() = pt g w (, xt ) = 0
t=1
where pt are probabilities implied by the moment conditions.

Outline
GMM in finance
GMM with R
GEL with R
GEL in finance
Whats next?
GEL
The GEL estimator is defined as:
T
X
n = arg min hT (pt ),
,pt
t=1
subject to
XT
pt g w (, xt ) = 0 and
t=1
T
X
pt = 1,
t=1
where h() is a discrepancy function which measure the

distance between the empirical density 1/T and pt .
Outline
GMM in finance
GMM with R
GEL with R
GEL in finance
Whats next?
GEL
It can be shown that it is equivalent to the following saddle point

problem which is how it is computed numerically:
" T
#
1X
= arg min max g w (, xt ) (1)
T
t=1
for some (), where is the Lagrange multiplier associated with

the moment conditions. The popular functions are:
(v) = ev : Exponential tilting
(v) = log (1 v): Empirical likelihood
(v) = 0.5v 2 : continuous updated GMM

Outline
GMM in finance
GMM with R
GEL with R
GEL in finance
Whats next?
GEL
It can be shown that it is equivalent to the following saddle point

problem which is how it is computed numerically:
" T
#
1X
= arg min max g w (, xt ) (1)
T
t=1
for some (), where is the Lagrange multiplier associated with

the moment conditions. The popular functions are:
(v) = ev : Exponential tilting
(v) = log (1 v): Empirical likelihood
(v) = 0.5v 2 : continuous updated GMM

Outline
GMM in finance
GMM with R
GEL with R
GEL in finance
Whats next?
The function gel()
gel(g,x,tet0,gradv=NULL,smooth=FALSE,
type=c("EL","ET","CUE","ETEL"))
Other options:
kernel = c("Bartlett", "Parzen", "Truncated",
"Tukey-Hanning")
bw=bwAndrews2
tol_obj
maxiterlam
constraint=TRUE
optlam=c("iter","numeric")

Outline
GMM in finance
GMM with R
GEL with R
GEL in finance
Whats next?
CAPM
I choose the truncated kernel which corresponds to the HAC

computed with the Parzen kernel.
> rf <- Finance$rf[1:300]
> zm <- matrix(rm - rf, t, 1)
> res1 <- gmm(z ~ zm, x = zm)
> x <- cbind(1, zm)
> res <- gel(z ~ zm, x = x, res1$par[11:20], smooth = TRUE, kernel = "Truncated",
+ intercept = FALSE)
> summary(res)$test
statistics p-value
LR test 12.09362 0.2788400
LM test 11.53989 0.3170287
J test 12.19297 0.2723491

Outline
GMM in finance
GMM with R
GEL in finance
Whats next?
Some ideas
Add more flexibility to the optimization algorithm: ex. allow

constraints on parameters.
Simplify the method for nonlinear models. Make it as
simple as "nls()"
Add a procedure for simulated method of moments
any more suggestions are welcome.

C Hausse

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Outline

GMM and GEL with R

UQM and CIRPE

Rmetrics Workshop 2009

Articles on which this presentation is based:

Chauss(2009), "Computing Generalized Empirical

Jagannathan, Skoulakis and Wang(2002), "Generalized

Cochrane(2001), "Asset Pricing", Princeton University

We want to estimate the vector of parameters 0 Rp based on

where g() is a q 1 vector of moment conditions, with q p,

where zt It and f () is any function.

Pierre Chauss GMM and GEL with R

We want to estimate the vector of parameters 0 Rp based on

where g() is a q 1 vector of moment conditions, with q p,

where zt It and f () is any function.

Pierre Chauss GMM and GEL with R

We want to estimate the vector of parameters 0 Rp based on

where g() is a q 1 vector of moment conditions, with q p,

where zt It and f () is any function.

Pierre Chauss GMM and GEL with R

GMM: The estimator

Pierre Chauss GMM and GEL with R

GMM: The estimator

Pierre Chauss GMM and GEL with R

GMM: The HAC estimator

where, kh (s) is a kernel, h is the bandwidth which can be

and is a convergent estimate of 0 .

GMM: The three methods

Two step GMM (Hansen (1982))

= arg min g() ()1 g()

Pierre Chauss GMM and GEL with R

GMM: The three methods

Two step GMM (Hansen (1982))

= arg min g() ()1 g()

Pierre Chauss GMM and GEL with R

GMM: The three methods

Two step GMM (Hansen (1982))

= arg min g() ()1 g()

Pierre Chauss GMM and GEL with R

Pierre Chauss GMM and GEL with R

Pierre Chauss GMM and GEL with R

The micro-foundations of the pricing equation:

E (mt+1 Ri,t+1 |It ) = 1 for i = 1, ..., N,

where Ri,t is the gross return of asset i and mt+1 is the

Pierre Chauss GMM and GEL with R

The micro-foundations of the pricing equation:

E (mt+1 Ri,t+1 |It ) = 1 for i = 1, ..., N,

where Ri,t is the gross return of asset i and mt+1 is the

Pierre Chauss GMM and GEL with R

The moment conditions become:

The CAPM implies the following relations:

E (Rit ) Rf = i [E (Rm,t ) Rf ] for i = 1, ..., N

which can be tested using the following regression:

Rit Rf = i + i (Rm,t Rf ) + it for i = 1, ..., N

It can be estimated by GMM using:

where t = {1t , ..., Nt } and is the Kronecker product.

Pierre Chauss GMM and GEL with R

The CAPM implies the following relations:

E (Rit ) Rf = i [E (Rm,t ) Rf ] for i = 1, ..., N

which can be tested using the following regression:

Rit Rf = i + i (Rm,t Rf ) + it for i = 1, ..., N

It can be estimated by GMM using:

where t = {1t , ..., Nt } and is the Kronecker product.