Equilibrium “Anomalies”

Topics:
Decision Analysis
Tags:
Anomaly,
CAPM,
Equity,
Finance,
Financial Services,
Investment,
Leverage,
Smb/Sme
Source:
American Finance Association

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Overview: Many empirical “anomalies” are actually consistent with the single beta CAPM if the empiricist utilizes an equity-only proxy for the true market portfolio. CAPM is basically a method of decision-making w.r.t. any kind of investment in any asset. Equity betas estimated against this particular inefficient proxy will be understated, with the error increasing with the firm’s leverage. Thus, firm-specific variables that correlate with leverage will appear to explain returns after controlling for proxy beta simply because they capture the missing beta risk. Loadings on portfolios formed on relative leverage and relative distress completely subsume the powers of the Fama and French (1993) SMB and HML factors in explaining crosssectional returns. Thus, CAPM plays an instrumental role in the success of the organisation.

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Format: PDF | Size: 338KB | Date: Jan 2003 | Pages: 49

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