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Can the CRRA-Lognormal Framework Explain CAPM-Anomalies in the Cross-Section of Stock Returns?

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  • Sabine Elmiger

    (University of Zurich)

Abstract

A large number of empirical studies find systematic deviations from the CAPM. The CAPM tends to understate the returns on low-beta stocks and overstate the returns on high-beta stocks, i.e. the security market line is too steep. Other well-documented anomalies are the size premium and the value premium. The CAPM is a special case of the consumption-based CAPM. This study adresses the question whether the consumption-based CAPM with constant relative risk aversion preferences and lognormally distributed dividends can explain CAPM-anomalies. An example of an economy with power utility and lognormal dividends is examined that can be solved in closed form. The model leads to a security market line that is flatter than in the CAPM and generates a size and a value premium. The comparative statics suggest that cross-sectional anomalies and the equity premium puzzle are tightly linked.

Suggested Citation

  • Sabine Elmiger, 2013. "Can the CRRA-Lognormal Framework Explain CAPM-Anomalies in the Cross-Section of Stock Returns?," Swiss Finance Institute Research Paper Series 13-43, Swiss Finance Institute, revised Oct 2016.
    • Handle: RePEc:chf:rpseri:rp1343
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