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The Capm Is Alive And Well

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  • Ravi Jagannathan

    (Finance Department, University of Minnesota)

  • Zhenyu Wang

    (Department of Economics, University of Minnesota)

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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Bibliographic Info

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

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

Note: 57 pages, postscript
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Web page: http://128.118.178.162

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