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The Capm Is Alive And Well

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Author Info
Ravi Jagannathan (Finance Department, University of Minnesota)
Zhenyu Wang (Department of Economics, University of Minnesota)

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Abstract

In empirical studies of the CAPM, it is commonly assumed that, (a) the return to the value-weighted portfolio of all stocks is a reasonable proxy for the return on the market portfolio of all assets in the economy, and (b) betas of assets remain constant over time. Under these assumptions, Fama and French (1992) find that the relation between average return and beta is flat. We argue that these two auxiliary assumptions are not reasonable. We demonstrate that when these assumptions are relaxed, the empirical support for the CAPM is very strong. When human capital is also included in measuring wealth, the CAPM is able to explain 28\% of the cross sectional variation in average returns in the 100 portfolio studied by Fama and French. When, in addition, betas are allowed to vary over the business cycle, the CAPM is able to explain 57\%. More important, relative size does not explain what is left unexplained after taking sampling errors into account.

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Paper provided by EconWPA in its series Finance with number 9402001.

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Length: 57 pages
Date of creation: 28 Feb 1994
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Handle: RePEc:wpa:wuwpfi:9402001

Note: 57 pages, postscript
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Web page: http://129.3.20.41

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G - Financial Economics

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  1. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing Specification Errors in Stochastic Discount Factor Models," NBER Technical Working Papers 0153, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Maroney, Neal C. & Protopapadakis, Aris A., 1999. "The book-to-market and size effects in a general asset pricing model: evidence from seven national markets," Working Papers 1999-15, University of New Orleans, Department of Economics and Finance. [Downloadable!]
  3. David Blake, 2004. "The impact of wealth on consumption and retirement behaviour in the UK," Applied Financial Economics, Taylor and Francis Journals, vol. 14(8), pages 555-576, May. [Downloadable!] (restricted)
  4. Campbell R. Harvey, 1994. "Predictable Risk and Returns in Emerging Markets," NBER Working Papers 4621, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. John H. Boyd & Ravi Jagannathan & Jian Hu, 2001. "The Stock Market's Reaction to Unemployment News: Why Bad News is Usually Good for Stocks," NBER Working Papers 8092, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Patricio Arrau & Rómulo Chumacero, 1998. "Tamaño de los Fondos de Pensiones en Chile y su Desempeño Financiero," Cuadernos de Economía (Latin American Journal of Economics), Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 35(105), pages 205-236. [Downloadable!]
  7. Moshe Levy & Yaacov Ritov, 2001. "Portfolio Optimization with Many Assets: The Importance of Short-Selling," University of California at Los Angeles, Anderson Graduate School of Management 1006, Anderson Graduate School of Management, UCLA. [Downloadable!]
  8. Kent Daniel & Sheridan Titman, 1996. "Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," NBER Working Papers 5604, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Saffi, Pedro, 2008. "Expected returns and liquidity risk: Does entrepreneurial income matter?," IESE Research Papers D/749, IESE Business School. [Downloadable!]
  10. Ravi Jagnnathan & Ellen R. McGrattan, 1995. "The CAPM debate," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 2-17. [Downloadable!]
  11. Shmuel Kandel & Robert F. Stambaugh, 1994. "Portfolio Inefficiency and the Cross-Section of Expected Returns," NBER Working Papers 4702, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Wayne E. Ferson & Ravi Jagannathan, 1996. "Econometric evaluation of asset pricing models," Staff Report 206, Federal Reserve Bank of Minneapolis. [Downloadable!]
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