Abstract
We develop a theory of arbitrage-free dispersion (AFD) that
characterizes the testable restrictions of asset pricing models.
AFD measures Jensen’s gap in the cumulant generating function
of pricing kernels and returns. It implies a wide family of modelfree
dispersion constraints, which extend dispersion and codispersion
bounds in the literature and are applicable with a
unifying approach in multivariate and multiperiod settings.
Empirically, the dispersion of stationary and martingale pricing
kernel components in the benchmark long-run risk model yields
a counterfactual dependence of shortvs. long-maturity bond
returns and is insufficient for pricing optimal portfolios of market
equity and short-term bonds.