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Linear beta pricing with efficient/inefficient benchmarks and short-selling restrictions

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  • Diacogiannis, George
  • Ioannidis, Christos

Abstract

We provide two security pricing models that can be used when short sales of risky securities are not permitted. The first model uses a benchmark located on the expected return-standard deviation efficient frontier without short sales and presents security expected returns as a weighted linear function of two betas, one induced by the benchmark and the other adjusting for the short-sale constraints. The second model uses a benchmark that is inefficient relative to the efficient frontier, does not allow short sales, and expresses security returns as a weighted linear function of three betas:one induced by the inefficient benchmark, and the other two adjusting simultaneously for the short-sales restrictions and the benchmark's inefficiency.These results complement the linear pricing models that link expected returns and betas by allowing, for efficient or inefficient expected return-standard deviation, benchmarks with restricted short sales.

Suggested Citation

  • Diacogiannis, George & Ioannidis, Christos, 2022. "Linear beta pricing with efficient/inefficient benchmarks and short-selling restrictions," International Review of Financial Analysis, Elsevier, vol. 81(C).
  • Handle: RePEc:eee:finana:v:81:y:2022:i:c:s1057521921003173
    DOI: 10.1016/j.irfa.2021.102003
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