An empirical investigation of asset pricing models under divergent lending and borrowing rates

Asset pricing theory implies that the estimate of the zero-beta rate should fall between divergent lending and borrowing rates. This paper proposes a formal test of this restriction using the difference between the prime loan rate and the 1-month Treasury bill rate as a proxy for the difference between borrowing and lending rates. Based on simulations, this paper shows that in the ordinary least squares case, the Fama and MacBeth (J Pol Econ 81:607–636, 1973 ) t-statistic has high power against a general alternative, which is not true of the Shanken (Rev Financ Stud 5:1–33, 1992 ) and Kan et al. (J Financ doi: 10.1111/jofi.12035 , 2013 ) t-statistics. In the generalized least squares case, all three t-statistics have high power. The empirical investigation highlights that only the intertemporal capital asset pricing model reasonably prices the zero-beta portfolio. Other models, such as the Fama and French (J Financ Econ 33:3–56, 1993 ) model, do not assign the correct value to the zero-beta rate. Copyright Swiss Society for Financial Market Research 2014