Jensen Bounds: Testable Restrictions on Asset Pricing Models

Abstract

This paper develops a systematic framework for testing asset-pricing models, with a particular focus on obtaining testable restrictions on the joint distribution of multiple SDFs. Our framework takes an arbitrary set of empirical and/or theoretical restrictions—such as observable returns and Euler equations—as a primitive and returns a family of necessary conditions on the joint distribution of SDFs that have to be satisfied if the model is to be consistent with the a priori specified restrictions. Applying our main results to international asset-pricing models, we show that observed asset prices imply non-trivial restrictions on the comovement of SDFs of different countries.