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Journal of Finance Vol. 59 No. 4 2004

Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing

Michael J. Brennan1; Ashley Wang2,3,4,5,6,7,8,9,10,11; Yihong Xia10,11

1 A&F Accounting & Finance · 2 University of Notre Dame · 3 University of California, Los Angeles · 4 Wharton County Junior College · 5 National Taiwan University · 6 Hong Kong University of Science and Technology · 7 William P. Wharton Trust · 8 Indiana University · 9 Carnegie Mellon University · 10 University of Pennsylvania · 11 University of Hong Kong

Abstract

A simple valuation model with time‐varying investment opportunities is developed and estimated. The model assumes that the investment opportunity set is completely described by the real interest rate and the maximum Sharpe ratio, which follow correlated Ornstein–Uhlenbeck processes. The model parameters and time series of the state variables are estimated using U.S. Treasury bond yields and expected inflation from January 1952 to December 2000, and as predicted, the estimated maximum Sharpe ratio is related to the equity premium. In cross‐sectional asset‐pricing tests, both state variables have significant risk premia, which is consistent with Merton's ICAPM.

DOI
10.1111/j.1540-6261.2004.00678.x
Volume
59
Issue
4
Pages
1743-1776
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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