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Resurrecting the (C)CAPM: A CrossSectional Test When Risk Premia Are TimeVarying
 Journal of Political Economy
, 2001
"... This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditio ..."
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Cited by 137 (4 self)
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This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditional models perform far better than unconditional specifications and about as well as the FamaFrench threefactor model on portfolios sorted by size and booktomarket characteristics. The conditional consumption CAPM can account for the difference in returns between lowbooktomarket and highbooktomarket portfolios and exhibits little evidence of residual size or booktomarket effects. We are grateful to Eugene Fama and Kenneth French for graciously providing the
Idiosyncratic risk matters
 Journal of Finance
, 2003
"... This paper takes a new look at the tradeoff between risk and return in the stock market. We find a significant positive relation between average stock variance and the return on the market. There is, therefore, a tradeoff between risk and return in the stock market, except that risk is measured as t ..."
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Cited by 39 (4 self)
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This paper takes a new look at the tradeoff between risk and return in the stock market. We find a significant positive relation between average stock variance and the return on the market. There is, therefore, a tradeoff between risk and return in the stock market, except that risk is measured as total risk, including idiosyncratic risk, rather than only systematic risk. Further, we find that the variance of the market by itself has no forecasting power for the market return. These relations persist after we control for macroeconomic variables known to forecast the stock market. We show that idiosyncratic risk explains most of the variation of average stock risk through time and it is idiosyncratic risk that drives the forecastability of the stock market.
TwoPass Tests of Asset Pricing Models with Useless Factors
, 1997
"... In this paper we investigate the properties of the standard twopass methodology of testing beta pricing models with misspecified factors. In a setting where a factor is useless, defined as being independent of all the asse t returns, we provide theoretical results and simulation evidence that the s ..."
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Cited by 36 (4 self)
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In this paper we investigate the properties of the standard twopass methodology of testing beta pricing models with misspecified factors. In a setting where a factor is useless, defined as being independent of all the asse t returns, we provide theoretical results and simulation evidence that the secondpass crosssectional regression tends to find the beta risk of the useless factor priced more often than it should. More surprisingly, this misspecification bias exacerbates when the number of time series observations increases. Possible ways of detecting useless factors are also examined. When testing asset pricing models relating risk premiums on assets to their betas, the primary question of interest is whether the beta risk of a particular factor is priced (i.e., whether the estimated risk premium associated with a given factor is significantly di#erent from zero). Black, Jensen, and Scholes (1972) and Fama and MacBeth (1973) develop a twopass methodology in which the beta of each asset with respect to a factor is estimated in a firstpass time series regression, and estimated betas are then used in secondpass crosssectional regressions (CSRs) to estimate the risk premium of the factor. This twopass methodology is very intuitive and has been widely used in the literature. The properties of the test statistics and goodnessoffit measures under the twopass methodology are usually developed under the assumptions that the asset pricing model is correctly specified and that the factors are correctly identified. Shanken (1992) provides an excellent discussion of this twopass methodology, especially the large sample properties of the twopass CSR for the correctly specified model under the assumption that returns are conditionally homoskedastic. Jagannathan and Wa...
On the estimation of beta pricing models
 Review of Financial Studies
, 1992
"... An integrated econometric view of maximum likelihood methods and more traditional twopass approaches to estimating betapricing models is presented. Several aspects of the wellknown “errorsinvariables problem ” are considered, and an earlier conjecture concerning the merits of simultaneous estim ..."
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Cited by 35 (1 self)
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An integrated econometric view of maximum likelihood methods and more traditional twopass approaches to estimating betapricing models is presented. Several aspects of the wellknown “errorsinvariables problem ” are considered, and an earlier conjecture concerning the merits of simultaneous estimation of beta and price of risk parameters is evaluated. The traditional inference procedure is found, under standard assumptions, to overstate the precision of price of risk estimates and an asymptotically valid correction is derived. Modifications to accommodate serial correlation in marketwide factors are also discussed Sharpe (1964) and Lintner (1965) demonstrate that, in equilibrium, a financial asset’s expected return must be positively linearly related to its “beta, ” a measure of systematic risk or comovement with the market portfolio return: 1 This article is an extension of the second chapter of my doctoral dissertation at Carnegie Mellon University. Recent versions were presented in seminars
The Capital Asset Pricing Model: Theory and Evidence
 JOURNAL OF ECONOMIC PERSPECTIVES—VOLUME 18, NUMBER 3—SUMMER 2004—PAGES 25–46
, 2004
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Idiosyncratic risk and security returns
, 2002
"... The traditional CAPM approach argues that only market risk should be incorporated into asset prices and command a risk premium. This result may not hold, however, if some investors can not hold the market portfolio. For example, if one group of investors fails to hold the market portfolio for exogen ..."
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Cited by 10 (0 self)
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The traditional CAPM approach argues that only market risk should be incorporated into asset prices and command a risk premium. This result may not hold, however, if some investors can not hold the market portfolio. For example, if one group of investors fails to hold the market portfolio for exogenous reasons, the remaining investors will also be unable to hold the market portfolio. Therefore, idiosyncratic risk could also be priced to compensate rational investors for an inability to hold the market portfolio. A variation of the CAPM model is derived to capture this observation as well as to draw testable implications. Under both the Fama and MacBeth (1973) and Fama and French (1992) testing frameworks, we find that idiosyncratic volatility is useful in explaining crosssectional expected returns. We also discover that returns from constructed portfolios directly covary with idiosyncratic risk hedging portfolio returns.
What Determines Chinese Stock Returns?
"... Size, not booktomarket, helps to explain crosssectional differences in Chinese stock returns from 19962002. Similar to the U.S. experience, beta does not account for return differences among individual stocks. Due to the speculative nature of the Chinese capital markets and low quality in the ac ..."
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Cited by 5 (0 self)
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Size, not booktomarket, helps to explain crosssectional differences in Chinese stock returns from 19962002. Similar to the U.S. experience, beta does not account for return differences among individual stocks. Due to the speculative nature of the Chinese capital markets and low quality in the accounting information, these results suggest that the booktomarket variable may have reflected fundamentals in the U.S. markets. Due to the unique nature of the traded Chinese companies, we have proposed using a floating ratio as a proxy for fundamentals. Floating ratio reflects the expected corporate governance in China, which help to predict a firm’s future cash flow. Not only the crosssectional evidence highly supports our prediction for the floating ratio variable, a threefactor model which includes size and ratio proxies has significantly increased the explanatory power of a market model from 81 % to 90%.
2003) : “Two Paradigms and Nobel Prizes in Economics: a Contradiction or Coexistence?”, NCCRFinrisk Working Paper No
"... Markowitz and Sharpe won the Nobel Prize in Economics for the development of MeanVariance (MV) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected uti ..."
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Cited by 4 (3 self)
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Markowitz and Sharpe won the Nobel Prize in Economics for the development of MeanVariance (MV) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected utility (EU) maximization in the face of risk aversion. Kahneman and Tversky suggest Prospect Theory (PT) as an alternative paradigm to EU theory. They show that investors distort probabilities, make decisions based on change of wealth, exhibit loss aversion and maximize the expectation of an Sshaped value function, which contains a riskseeking segment. Can these two apparently contradictory paradigms coexist? We show in this paper that although CPT (and PT) is in conflict to EUT, and violates some of the CAPM’s underlying assumptions, the Security Market Line Theorem (SMLT) of the CAPM is intact in the CPT framework. Therefore, the CAPM is intact also in CPT framework.
Introduction to Asset Pricing Theory and Tests
 in The International Library of Critical Writings in Financial Economics
, 2001
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Sunspots, Iterative TwoPass CrossSectional Regressions, and Asymptotic Principal Components
, 2002
"... This paper considers two methods of estimating factor mimicking portfolios from asset returns: twopass crosssectional regression and asymptotic principal components. We show that, for a balanced panel of assets, iterating the twopass crosssectional regression converges to the same estimated fact ..."
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This paper considers two methods of estimating factor mimicking portfolios from asset returns: twopass crosssectional regression and asymptotic principal components. We show that, for a balanced panel of assets, iterating the twopass crosssectional regression converges to the same estimated factor portfolios regardless of the initial prespecified factors.. Moreover, those estimates are equal to the Connor and Korajczyk (1986) asymptotic principal components (APC) estimates (again, within a linear transformation of rank k). For unbalanced panels, identical MLE estimates (assuming normally distributed asset returns) are obtaind from ITPCSR and an iterated version of APC. Again, the alternative estimates converge regardless of the initial factors chosen to start the ITPCSR. The estimates are quasiMLE for actual return data since asset returns demonstrate nonnormalities. In this case, we find evidence that the estimates can converge to different local maxima of the objective function.