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Can CRRA preferences explain CAPM-anomalies in the cross-section of stock returns?

By Sabine Elmiger

Abstract

A large number of empirical studies find evidence for systematic deviations from the CAPM. The CAPM tends to understate the returns on low-beta stocks and overstate the returns on high-beta stocks, which means that the security market line is too steep. Other well-documented anomalies are the size premium and the value premium. The CAPM is a special case of the consumption-based CAPM. This study addresses the question whether the consumption-based CAPM with constant relative risk aversion preferences can explain CAPM-anomalies. An example of an economy with power utility and lognormal returns is examined that can be solved in closed form. The model leads to a security market line that is flatter than in the CAPM and generates a size and a value premium. The comparative statics suggest that cross-sectional anomalies and the equity premium puzzle are of a very similar nature

Topics: Department of Banking and Finance, 330 Economics
Year: 2013
DOI identifier: 10.5167/uzh-93699
OAI identifier: oai:www.zora.uzh.ch:93699
Provided by: ZORA

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