Learning about Beta: A New Look at CAPM Tests

Topics:
Investment and Capital Markets
Tags:
Capital Asset Pricing Model,
Federal Reserve Bank Of New York
Source:
Federal Reserve Bank of New York

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Overview: This paper develops an equilibrium model of learning about time-varying beta. In the model, the capital asset pricing model (CAPM) works for investors' probability distribution. However, mispricing can be observed if econometricians estimate betas without accounting for the investors' learning process. The empirical implication for asset-pricing tests is that the factor loadings must be estimated as latent variables. The paper provides an empirical application of this methodology to the cross section of returns on ten book-to-market and ten size-sorted portfolios. For these assets, the data do not reject a learning-augmented version of CAPM.

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Format: PDF | Size: 809KB | Date: Sep 2004 | Pages: 69

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