Multifactor Models Do Not Explain Deviations From the CAPM (Revised: 21-94)
Evidence of deviations from the Capital Asset Pricing Model (CAPM) has accumulated over the past decades. The source of these deviations is often assumed to be missing risk factors, leading researchers to look to multifactor asset pricing models as alternatives. The analysis in this paper suggests that consideration of different alternatives may be fruitful, since existing evidence against the CAPM is also evidence against multifactor alternatives being the whole story. Data-snooping biases, market failure, or market inefficiencies are more likely explanations for the deviations. The framework creates for the analysis provides additional insights. These insights relate to the role of residual risk in explaining the cross-section of expected asset returns and to the formation of prior distributions for Bayesian analysis of portfolio efficiency.
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