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Cross-sectional tests of the CAPM and Fama-French three-factor model

  • Grauer, Robert R.
  • Janmaat, Johannus A.
Registered author(s):

    Grouping does not produce a wide range of betas. Consequently, cross-sectional tests of the CAPM are bound to lack power. This paper provides a simple way to alleviate the problem by repackaging the data with zero-weight portfolios. When the CAPM is true and the data are repackaged, simulation shows that the average values of the intercept and slope converge to their true values more rapidly and there are striking increases in R2 and the power of the tests. Empirical results are dramatically different in datasets with and without the zero-weight portfolios.

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    File URL: http://www.sciencedirect.com/science/article/B6VCY-4X24VN6-1/2/36a9bd9e1049bfa79179631bb045f943
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    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 34 (2010)
    Issue (Month): 2 (February)
    Pages: 457-470

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    Handle: RePEc:eee:jbfina:v:34:y:2010:i:2:p:457-470
    Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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    1. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-52, September.
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    3. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
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    7. Grauer, Robert R. & Janmaat, Johannus A., 2004. "The unintended consequences of grouping in tests of asset pricing models," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 2889-2914, December.
    8. Raymond Kan & Cesare Robotti & Jay Shanken, 2013. "Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology," Journal of Finance, American Finance Association, vol. 68(6), pages 2617-2649, December.
    9. Ronald J. Balvers & Dayong Huang, 2005. "Evaluation Of Linear Asset Pricing Models By Implied Portfolio Performance," Working Papers 05-06old2 Classification-, Department of Economics, West Virginia University.
    10. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    11. 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.
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    13. 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.
    14. Post, Thierry & van Vliet, Pim & Levy, Haim, 2008. "Risk aversion and skewness preference," Journal of Banking & Finance, Elsevier, vol. 32(7), pages 1178-1187, July.
    15. Blume, Marshall E & Friend, Irwin, 1973. "A New Look at the Capital Asset Pricing Model," Journal of Finance, American Finance Association, vol. 28(1), pages 19-33, March.
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