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Cross-sectional tests of the CAPM and Fama-French three-factor model

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  • Grauer, Robert R.
  • Janmaat, Johannus A.
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    Abstract

    Grouping does not produce a wide range of betas. Consequently, cross-sectional tests of the CAPM are bound to lack power. This paper provides a simple way to alleviate the problem by repackaging the data with zero-weight portfolios. When the CAPM is true and the data are repackaged, simulation shows that the average values of the intercept and slope converge to their true values more rapidly and there are striking increases in R2 and the power of the tests. Empirical results are dramatically different in datasets with and without the zero-weight portfolios.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 34 (2010)
    Issue (Month): 2 (February)
    Pages: 457-470

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    Handle: RePEc:eee:jbfina:v:34:y:2010:i:2:p:457-470

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Asset pricing Econometric and statistical methods;

    References

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    1. Pantzalis, Christos & Park, Jung Chul, 2009. "Equity market valuation of human capital and stock returns," Journal of Banking & Finance, Elsevier, Elsevier, vol. 33(9), pages 1610-1623, September.
    2. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 47(2), pages 427-65, June.
    3. Ronald J. Balvers & Dayong Huang, 2005. "Evaluation Of Linear Asset Pricing Models By Implied Portfolio Performance," Working Papers 05-06 Classification- JEL, Department of Economics, West Virginia University.
    4. Raymond Kan & Cesare Robotti & Jay Shanken, 2009. "Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology," NBER Working Papers 15047, National Bureau of Economic Research, Inc.
    5. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
    6. Blume, Marshall E & Friend, Irwin, 1973. "A New Look at the Capital Asset Pricing Model," Journal of Finance, American Finance Association, American Finance Association, vol. 28(1), pages 19-33, March.
    7. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 19(3), pages 425-442, 09.
    8. Post, Thierry & van Vliet, Pim & Levy, Haim, 2008. "Risk aversion and skewness preference," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(7), pages 1178-1187, July.
    9. Grauer, Robert R. & Janmaat, Johannus A., 2004. "The unintended consequences of grouping in tests of asset pricing models," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(12), pages 2889-2914, December.
    10. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, Elsevier, vol. 4(2), pages 129-176, March.
    11. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
    12. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, Econometric Society, vol. 57(5), pages 1121-52, September.
    13. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-55, July.
    14. Grauer, Robert R. & Janmaat, Johannus A., 2009. "On the power of cross-sectional and multivariate tests of the CAPM," Journal of Banking & Finance, Elsevier, Elsevier, vol. 33(5), pages 775-787, May.
    15. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, American Finance Association, vol. 51(1), pages 55-84, March.
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