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Journal of Financial and Quantitative Analysis Vol. 55 No. 3 2020

Capital Asset Pricing with a Stochastic Horizon

Michael J. Brennan1,2,3,4; Yuzhao Zhang5

1 University of California, Los Angeles · 2 Brennan Center for Justice · 3 Brennan & Company (Ireland) · 4 Manchester University · 5 Rutgers Sexual and Reproductive Health and Rights

open access

Abstract

In this paper we present empirical tests of an extended version of the capital asset pricing model (CAPM) that replaces the single-period horizon with a probability distribution over different horizons. Adopting a simple parameterization of the probability distribution of the length of the horizon, we estimate the parameters of the distribution as well as the parameters of the CAPM. We find that the extended model is not rejected for several different samples of common stocks, and for these samples it outperforms not only the standard CAPM but also the Fama–French (1993) 3-factor model. The probability distribution over horizon dates varies over time with the New York Stock Exchange (NYSE) turnover rate. We also find that returns satisfy the Euler equation of a representative financial institution that holds the market portfolio and has horizon probabilities estimated from 13F filings.

DOI
10.1017/s0022109018001412
Volume
55
Issue
3
Pages
783-827
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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