Journal of Financial Economics Vol. 131 No. 2 2019

The CAPM strikes back? An equilibrium model with disasters

Hang Bai¹; Kewei Hou²; Howard Kung^3,4; Erica X. N. Li⁵; Lu Zhang^6,2

¹ University of Connecticut · ² Fisher College · ³ London Business School · ⁴ Center for Economic and Policy Research · ⁵ Cheung Kong Graduate School of Business · ⁶ National Bureau of Economic Research

Abstract

Embedding disasters into a general equilibrium model with heterogeneous firms induces strong nonlinearity in the pricing kernel, helping explain the empirical failure of the (consumption) CAPM. Our single-factor model reproduces the failure of the CAPM in explaining the value premium in finite samples without disasters and its relative success in samples with disasters. Due to beta measurement errors, the estimated beta-return relation is flat, consistent with the beta “anomaly,” even though the true beta-return relation is strongly positive. Finally, the consumption CAPM fails in simulations, even though a nonlinear model with the true pricing kernel holds exactly by construction.

DOI

10.1016/j.jfineco.2018.08.009

Volume

131

Issue

2

Pages

269-298

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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