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"Shooting" the CAPM

  • Lu Zhang

    (The Ohio State University)

  • Howard Kung

    (University of British Columbia)

  • Hang Bai

    (The Ohio State University)

Registered author(s):

    We provide a disaster-based explanation for the failure of the CAPM in the post-Compustat sample as well as its success to explain the value premium in the long sample that includes the Great Depression. In an investment-based asset pricing model embedded with rare disasters, value stocks are more sensitive to disaster shocks than growth stocks. More important, disasters introduce strong nonlinearities in the relation between the pricing kernel and the return on wealth. The nonlinearities allow the model to explain the failure of the CAPM in samples in which disasters are not materialized. However, the CAPM explains the value premium in samples with disasters in the model, consistent with the data.

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    Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 905.

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    Date of creation: 2013
    Date of revision:
    Handle: RePEc:red:sed013:905
    Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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    21. Georg Kaltenbrunner & Lars A. Lochstoer, 2010. "Long-Run Risk through Consumption Smoothing," Review of Financial Studies, Society for Financial Studies, vol. 23(8), pages 3190-3224, August.
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