A Concave Security Market Line
AbstractWe provide theoretical and empirical arguments in favor of a concave shape for the security market line, or a diminishing marginal premium for market risk. In capital market equilibrium with binding portfolio restrictions, different investors generally hold different sets of risky securities. Despite the differences in composition, the optimal portfolios generally share a joint exposure to systematic risk. Equilibrium in this case can be approximated by a concave relation between expected return and market beta rather than the traditional linear relation. An empirical analysis of U.S. stock market data confirms the existence of a significant and robust, concave cross-sectional relation between average return and estimated past market beta. We estimate that the market-risk premium is at least five to six percent per annum for the average stock, substantially higher than conventional estimates.
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Bibliographic InfoPaper provided by Koc University-TUSIAD Economic Research Forum in its series Koç University-TUSIAD Economic Research Forum Working Papers with number 1211.
Length: 54 pages
Date of creation: May 2012
Date of revision:
capital market equilibrium; asset pricing; investment restrictions; portfolio theory.;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-05-29 (All new papers)
- NEP-CFN-2012-05-29 (Corporate Finance)
- NEP-FMK-2012-05-29 (Financial Markets)
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