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Market Proxies, Correlation, and Relative Mean-Variance Efficiency: Still Living with the Roll Critique

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  • Todd, Prono

Abstract

A test of the CAPM is developed conditional on a prior belief about the correlation between the true market return and the proxy return used in the test. Consideration is given to the effect of the proxy's mismeasurement of the market return on the estimation of the market model. Failure to grant this consideration biases tests towards rejection by overstating the inefficiency of the proxy. An extension of the proposed test to a CAPM with conditioning information links mismeasurement of the market return to time-variation in beta.

Suggested Citation

  • Todd, Prono, 2009. "Market Proxies, Correlation, and Relative Mean-Variance Efficiency: Still Living with the Roll Critique," MPRA Paper 20031, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:20031
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    References listed on IDEAS

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    Cited by:

    1. Todd Prono, 2008. "GARCH-based identification and estimation of triangular systems," Risk and Policy Analysis Unit Working Paper QAU08-4, Federal Reserve Bank of Boston.

    More about this item

    Keywords

    Asset pricing; CAPM; portfolio efficiency; multivariate testing; bootstrap hypothesis testing; triangular systems; endogeneity; identification; GMM; conditional heteroskedasticity; GARCH;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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