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Determining the Number of Priced State Variables in the ICAPM


  • Fama, Eugene F.


Suppose the ICAPM governs asset prices and there is a total of S state variables that might be of hedging concern to investors. Can we determine which state variables are, in fact, of hedging concern? What does it mean to say that these state variables are priced, that is, that they give rise to special risk premiums in expected returns? The goal of this paper is to formulate this problem clearly and show when it can and cannot be solved. Ignoring estimation problems, it is possible to find the set of priced state variables when the state variables are identified (named). When we know the number of state variables, but not their names, confident conclusions about even the number of them that produce special risk premiums are probably impossible, unless the number is zero, so the ICAPM collapses to the CAPM.

Suggested Citation

  • Fama, Eugene F., 1998. "Determining the Number of Priced State Variables in the ICAPM," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(02), pages 217-231, June.
  • Handle: RePEc:cup:jfinqa:v:33:y:1998:i:02:p:217-231_00

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    Cited by:

    1. Fama, Eugene F. & French, Kenneth R., 2017. "International tests of a five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 123(3), pages 441-463.
    2. Polk, Christopher & Thompson, Samuel & Vuolteenaho, Tuomo, 2006. "Cross-sectional forecasts of the equity premium," Journal of Financial Economics, Elsevier, vol. 81(1), pages 101-141, July.
    3. repec:oup:rfinst:v:30:y:2017:i:4:p:1316-1338. is not listed on IDEAS
    4. Francisco Barillas & Jay Shanken, 2018. "Comparing Asset Pricing Models," Journal of Finance, American Finance Association, vol. 73(2), pages 715-754, April.
    5. Lioui, Abraham & Poncet, Patrice, 2003. "International asset allocation: A new perspective," Journal of Banking & Finance, Elsevier, vol. 27(11), pages 2203-2230, November.
    6. Maria PASCU-NEDELCU, 2011. "Merton Model For Assessing The Cost Of Capital, Mathematical Amount But Not Also Economic Amount Of Capm And Apt Models," Journal of Doctoral Research in Economics, The Bucharest University of Economic Studies, vol. 3(1), pages 47-61, March.
    7. Ball, Ray & Gerakos, Joseph & Linnainmaa, Juhani T. & Nikolaev, Valeri, 2016. "Accruals, cash flows, and operating profitability in the cross section of stock returns," Journal of Financial Economics, Elsevier, vol. 121(1), pages 28-45.
    8. Wayne E. Ferson & Andrew F. Siegel & Pisun (Tracy) Xu, 2005. "Mimicking Portfolios with Conditioning Information," NBER Working Papers 11020, National Bureau of Economic Research, Inc.
    9. repec:eee:jfinec:v:128:y:2018:i:2:p:234-252 is not listed on IDEAS
    10. Zhongzhi Lawrence He, 2018. "Comparing Asset Pricing Models: Distance-based Metrics and Bayesian Interpretations," Papers 1803.01389,
    11. Christopher Polk & Samuel Thompson & Tuomo Vuolteenaho, 2004. "New Forecasts of the Equity Premium," NBER Working Papers 10406, National Bureau of Economic Research, Inc.
    12. Aretz, Kevin & Bartram, Söhnke M. & Pope, Peter F., 2010. "Macroeconomic risks and characteristic-based factor models," Journal of Banking & Finance, Elsevier, vol. 34(6), pages 1383-1399, June.
    13. L'Her, Jean-Francois & Masmoudi, Tarek & Suret, Jean-Marc, 2004. "Evidence to support the four-factor pricing model from the Canadian stock market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 14(4), pages 313-328, October.
    14. Francisco Barillas & Jay Shanken, 2017. "Which Alpha?," Review of Financial Studies, Society for Financial Studies, vol. 30(4), pages 1316-1338.
    15. Cappiello, Lorenzo & Guéné, Stéphane, 2005. "Measuring market and inflation risk premia in France and in Germany," Working Paper Series 436, European Central Bank.
    16. Brav, Alon & Geczy, Christopher & Gompers, Paul A., 2000. "Is the abnormal return following equity issuances anomalous?," Journal of Financial Economics, Elsevier, vol. 56(2), pages 209-249, May.
    17. Hsu, Yuan-Teng & Huang, Chia-Wei, 2016. "Idiosyncratic risk and share repurchases," Finance Research Letters, Elsevier, vol. 18(C), pages 76-82.
    18. Hui Guo & Robert Savickas & Zijun Wang & Jian Yang, 2006. "Is value premium a proxy for time-varying investment opportunities: some time series evidence," Working Papers 2005-026, Federal Reserve Bank of St. Louis.
    19. repec:eee:ememar:v:31:y:2017:i:c:p:141-163 is not listed on IDEAS
    20. Vassalou, Maria, 2001. "News Related to Future GDP Growth as a Risk Factor in Equity Returns," CEPR Discussion Papers 3057, C.E.P.R. Discussion Papers.

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