Asset Pricing Factors and Beliefs

Authors: Federico Carlini, Andrea Maino and Fabio Trojani

Abstract

We propose a novel framework to recover investor beliefs, associated pricing kernels and corresponding asset pricing factors in arbitrage-free markets. Consistently with existing prior information on asset returns, our approach incorporates a possible deviations from rational expectations together with general forward looking asset pricing constraints in markets with, e.g., frictions or ambiguity. Our method nonparametrically identifies an information-based belief distortion supported by the given prior, and a pricing kernel consistent with the prevailing asset pricing constraints. Using our approach, we underscore an intrinsically opaque relation between relevant investor beliefs and asset pricing factors, which challenges the usefulness of a distinction between strong and weak factors for asset pricing.