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Portfolio Inefficiency and the Cross-Section of Expected Returns

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  • Shmuel Kandel
  • Robert F. Stambaugh

Abstract

A plot of expected returns versus betas obeys virtually no relation to an inefficient index portfolio's mean-variance location. If the index portfolio is inefficient, then the coefficients and R- squared from an ordinary-least-squares regression of expected returns on betas can equal essentially any desired values. The mean-variance location of the index does determine the properties of a cross- sectional mean-beta relation fitted by generalized least squares (GLS). As the index portfolio moves closer to exact efficiency, the GLS mean-beta relation moves closer to the exact linear relation corresponding to an efficient portfolio with the same variance. The goodness-of-fit for the GLS regression is the index portfolio's squared relative efficiency, which measures closeness to efficiency in mean-variance space.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4702.

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Date of creation: Apr 1994
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Publication status: published as Journal of Finance 50(1995):157-184.
Handle: RePEc:nbr:nberwo:4702

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  1. Kandel, Shmuel & Stambaugh, Robert F, 1989. "A Mean-Variance Framework for Tests of Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 2(2), pages 125-56.
  2. 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, vol. 4(2), pages 129-176, March.
  3. Roll, Richard, 1985. "A note on the geometry of Shanken's CSR T2 test for mean/variance efficiency," Journal of Financial Economics, Elsevier, vol. 14(3), pages 349-357, September.
  4. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
  5. Shanken, Jay, 1987. "Multivariate proxies and asset pricing relations : Living with the Roll critique," Journal of Financial Economics, Elsevier, vol. 18(1), pages 91-110, March.
  6. Shanken, Jay, 1985. "Multivariate tests of the zero-beta CAPM," Journal of Financial Economics, Elsevier, vol. 14(3), pages 327-348, September.
  7. Ross, Stephen A, 1977. "The Capital Asset Pricing Model (CAPM), Short-Sale Restrictions and Related Issues," Journal of Finance, American Finance Association, vol. 32(1), pages 177-83, March.
  8. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  9. Ravi Jagannathan & Zhenyu Wang, 1994. "The Capm Is Alive And Well," Finance 9402001, EconWPA.
  10. Kandel, Shmuel & Stambaugh, Robert F., 1987. "On correlations and inferences about mean-variance efficiency," Journal of Financial Economics, Elsevier, vol. 18(1), pages 61-90, March.
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  1. Existence Theorems
    by Eric Falkenstein in Falkenblog on 2008-04-23 16:27:00
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