General Tests of Latent Variable Models and Mean Variance Spanning (Reprint 031)

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Abstract
The methods of Gibbons and Ferson (1985) are extended, relaxing the assumption that expected returns are linear functions of predetermined instruments. A model of conditional mean variance spanning generalizes Huberman and Kandel (1987). The empirical results indicate that more than a single risk premium is needed to model expected stock and bond returns, but the number of common factors in the expected returns is small. However, when size-biased common stock portfolios proxy for the risk factors, we reject the hypothesis that four of them describe the conditional expected returns of the other assets.
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