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Π-CAPM: The Classical CAPM with Probability Weighting and Skewed Assets

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  • Joost Driessen
  • Sebastian Ebert
  • Joren Koëter

Abstract

We propose a new asset pricing model that generalizes the mean-variance framework by including probability weighting, specifically the overweighting of rare, high-impact events. Our model—the -CAPM—generates several new predictions: (i) skewness has a positive price effect, amplified by volatility; (ii) the price effect of volatility is negative for left-skewed assets but positive for right-skewed assets; and (iii) option-implied variance premiums for stocks have a U-shaped relation to skewness, amplified by volatility. We find strong empirical support for these predictions. Finally, we show that the -CAPM predicts an exaggerated co-movement of assets and can explain the correlation premium.

Suggested Citation

  • Joost Driessen & Sebastian Ebert & Joren Koëter, 2025. "Π-CAPM: The Classical CAPM with Probability Weighting and Skewed Assets," The Review of Financial Studies, Society for Financial Studies, vol. 38(12), pages 3497-3541.
    • Handle: RePEc:oup:rfinst:v:38:y:2025:i:12:p:3497-3541.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaf045
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    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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