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A Concave Security Market Line

Author

Listed:
  • Enrico G. De Giorgi

    () (School of Economics and Political Science, University of St. Gallen)

  • Thierry Post

    () (Koc University, Graduate School of Business)

  • Atakan Yalcin

    () (Koc University, Graduate School of Business)

Abstract

We provide theoretical and empirical arguments in favor of a concave shape for the security market line, or a diminishing marginal premium for market risk. In capital market equilibrium with binding portfolio restrictions, different investors generally hold different sets of risky securities. Despite the differences in composition, the optimal portfolios generally share a joint exposure to systematic risk. Equilibrium in this case can be approximated by a concave relation between expected return and market beta rather than the traditional linear relation. An empirical analysis of U.S. stock market data confirms the existence of a significant and robust, concave cross-sectional relation between average return and estimated past market beta. We estimate that the market-risk premium is at least five to six percent per annum for the average stock, substantially higher than conventional estimates.

Suggested Citation

  • Enrico G. De Giorgi & Thierry Post & Atakan Yalcin, 2012. "A Concave Security Market Line," Koç University-TUSIAD Economic Research Forum Working Papers 1211, Koc University-TUSIAD Economic Research Forum.
  • Handle: RePEc:koc:wpaper:1211
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    File URL: http://eaf.ku.edu.tr/sites/eaf.ku.edu.tr/files/erf_wp_1211.pdf
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    More about this item

    Keywords

    capital market equilibrium; asset pricing; investment restrictions; portfolio theory.;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models

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