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Yes, the CAPM is testable

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  • Guermat, Cherif

Abstract

It is well-known that cross-sectional tests of the CAPM are problematic. The market indexes used in empirical tests are likely to be inefficient ex ante, which could lead to spurious results even in the absence of sampling errors. This problem has led many to express serious doubt on the testability of the CAPM. In this paper I show that the CAPM is indeed testable. This paper builds on the seminal paper by Kandel and Stambaugh (1995) and proposes a two-step procedure for testing the CAPM. The first step uses a simple combination of the coefficients of determination from both Ordinary Least Squares and Generalised Least Squares estimations. This step tests whether the index used in the empirical test is efficient and whether there are no omitted factors. The second step tests the hypothesis that the efficient index is the market portfolio. The two-step approach enables testing the CAPM regardless of whether the true expected return generating process is a CAPM or a non-CAPM.

Suggested Citation

  • Guermat, Cherif, 2014. "Yes, the CAPM is testable," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 31-42.
    • Handle: RePEc:eee:jbfina:v:46:y:2014:i:c:p:31-42
    DOI: 10.1016/j.jbankfin.2014.05.001
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    Cited by:

    1. Ladislav Kristoufek & Paulo Ferreira, 2018. "Capital asset pricing model in Portugal: Evidence from fractal regressions," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 17(3), pages 173-183, November.
    2. Chikashi Tsuji, 2017. "A Robust Estimation of the CAPM with a Heavy-tailed Distribution," International Journal of Social Science Studies, Redfame publishing, vol. 5(5), pages 79-86, May.
    3. Levy, Moshe & Levy, Haim, 2015. "Keeping up with the Joneses and optimal diversification," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 29-38.
    4. Negrea, Bogdan & Toma, Mihai, 2017. "Dynamic CAPM under ambiguity—An experimental approach," Journal of Behavioral and Experimental Finance, Elsevier, vol. 16(C), pages 22-32.
    5. Vintilă Georgeta & Păunescu Radu Alin, 2015. "Econometric Tests of the CAPM Model for a Portfolio Composed of Companies Listed on Nasdaq and Dow Jones Components," Scientific Annals of Economics and Business, Sciendo, vol. 62(3), pages 453-480, November.

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    More about this item

    Keywords

    CAPM; Market portfolio; OLS; GLS;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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