The stable long-run CAPM and the cross-section of expected returns

The capital-asset-pricing model (CAPM) is one of the most popular methods of financial market analysis. But, evidence of the poor empirical performance of the CAPM has accumulated in the literature. For example, based on their empirical results regarding the relation between market Beta and average return, Fama and French (1996) conclude that the CAPM is no longer a useful tool for empirical financial market analysis. Most empirical studies of the conventional CAPM take, however, neither the fat-tails of return data nor the price relationship between an asset of interest and the bench market portfolio into account. In the framework of a univariate Beta-model we consider a stable long-run CAPM taking account of the fat-tails of stock returns and the common stochastic trends between stock prices. Using the same data used by Fama and French (1996), the stable long-run CAPM demonstrates that Markowitz rule of the expected returns and variance of returns can (still) -without any use of firm specific variables- explain the variation of the cross-sectional average returns. -- Das Capital-Asset-Pricing-Modell (CAPM) ist einer der populärsten empirischen Ansätze zur Analyse der Finanzmarktdaten. In der Literatur jedoch sind eher Gegenbeweise über seine empirische Tauglichkeit akkumuliert. Fama und French (1996) haben beispielsweise aufgrund ihrer empirischen Untersuchungsergebnisse über die Beziehung zwischen dem Markt-Beta und der Durchschnittsrendite schlussgefolgert, daß das CAPM keine nützliche Methode für empirische Finanzmarktanalyse mehr sein kann. Die meisten Arbeiten aber, die sich mit dem CAPM beschäftigen, berücksichtigen weder die ausreißerreiche empirische Renditenverteilung noch die Preisbeziehung zwischen dem einzelnen Kurs und dem Benchmark. In der vorliegenden Arbeit wird im Rahmen univariater Beta-Modelle ein Versuch zur Spezifikation eines stabilen langfristigen CAPM gemacht, das sowohl die ausreißerreiche empirische Renditenverteilung als auch die Preisbeziehung zwischen dem einzelnen Kurs und dem Benchmark berücksichtigt. Mit dem Datensatz von Fama und French (1996) wird gezeigt, daß das stabile langfristige CAPM in der Lage ist, anhand der Markowitz?schen Mittelwert-Varianz-Regel ?ohne Hinzufügen firmspezifischer Variablen? die Variabilität durchschnittlicher Rendite in Querschnittsdaten zu erklären.CAPM,Stable Paretian distribution,Sto chastic common trend

An Arbitrary Benchmark CAPM: One Additional Frontier Portfolio is Sufficient

The benchmark CAPM linearly relates the expected returns on an arbitrary asset, an arbitrary benchmark portfolio, and an arbitrary MV frontier portfolio. The benchmark is not required to be on the frontier and may be non-perfectly correlated with the frontier portfolio. The benchmark CAPM extends and generalizes previous CAPM formulations, including the zero beta, two correlated frontier portfolios, riskless augmented frontier, and inefficient portfolio versions. The covariance between the off-frontier benchmark and the frontier portfolio affects the systematic risk of any asset. Each asset has a composite beta, derived from the simple betas of both the asset and the benchmark.Benchmark; CAPM; non-frontier portfolio; zero beta portfolio; composite beta

Learning the CAPM through Bubbles

Bubbles are generally considered the outcome of investor irrationality or informational asymmetry, both objectionable in efficient markets with rational investors. We introduce an Intertemporal-CAPM with market clearing between high- and low-risk-averse rational investors who learn the CAPM under incomplete, yet symmetric information. Periodic equilibrium prices make a lognormal price process that nests the classic CAPM with a potential for endogenous bubbles through learning. The absence of comparables through the introductory phase of new technologies results in unstable return dynamics that might burst to bubbles or decline to near-zero, “pink-sheet†valuations. When the technology shifts phase to generate real profits the return dynamics is convergent, revealing the classic CAPM. Once the real technology return is observable, over- and under-pricing can be assessed, resulting in prompt positive or negative price adjustments toward the CAPM valuation. Correspondence with the Abreu and Brunnermeier (2003) model of bubbles with rational arbitrageurs is presented as well.ICAPM; Bubbles; New Technologies; Rational Expectations

On CAPM and Black-Scholes, differing risk-return strategies

In their path-finding 1973 paper Black and Scholes presented two separate derivations of their famous option pricing partial differential equation (pde). The second derivation was from the standpoint that was Black’s original motivation, namely, the capital asset pricing model (CAPM). We show here, in contrast, that the option valuation is not uniquely determined; in particular, strategies based on the delta-hedge and CAPM provide different valuations of an option although both hedges are instantaneouly riskfree. Second, we show explicitly that CAPM is not, as economists claim, an equilibrium theory.Capital asset pricing model (CAPM); nonequilibrium; financial markets; Black-Scholes; option pricing strategies;

Project valuation and investment decisions: CAPM versus arbitrage

This paper shows that (i) project valuation via disequilibrium NPV+CAPM contradicts valuation via arbitrage pricing, (ii) standard CAPM-minded decision makers may fail to profit from arbitrage opportunities, (iii) standard CAPM-based valuation violates value additivity. As a consequence, the standard use of CAPM for project valuation and decision making should be reconsidered.Investment, valuation, CAPM, arbitrage, disequilibrium NPV

Does the Conditional CAPM Work? Evidence from the Istanbul Stock Exchange

This paper tests whether the conditional CAPM accurately prices assets utilizing data from the Istanbul Stock Exchange (ISE) over the time period from February 1997 to April 2008. In our empirical analysis, we closely follow the methodology introduced in Lewellen and Nagel (2006). Our results show that the conditional CAPM fairs no better than the static counterpart in pricing assets. Although market betas do vary significantly over time, the intertemporal variation is not nearly large enough to drive average conditional alphas to zero.Conditional CAPM

Beta lives - some statistical perspectives on the capital asset pricing model

This note summarizes some technical issues relevant to the use of the idea of excess return in empirical modelling. We cover the case where the aim is to construct a measure of expected return on an asset and a model of the CAPM type is used. We review some of the problems and show examples where the basic CAPM may be used to develop other results which relate the expected returns on assets both to the expected return on the market and other factors

A Theoretical Extension of the Consumption-based CAPM Model

We extend the Consumption-based CAPM (C-CAPM) model for representative agents with different risk attitudes. We introduce the concept of expectation dependence and show that for a risk averse representative agent, it is the first-degree expectation dependence rather than the covariance that determines C-CAPM’s riskiness. We extend the assumption of risk aversion to prudence and provide a weaker dependence condition than first-degree expectation dependence to obtain the values of asset price and equity premium. Results are generalized to higher-degree risk changes and higher- order representative agents, and are linked to the equity premium puzzle.Consumption-based CAPM, Risk premium, Equity premium puzzle