BLANK

International Journal of Economics and Financial Issues
Vol. 2, No. 2, 2012, pp.141-178

ISSN: 2146-4138
www.econjournals.com
Theoretical and Empirical Review of Asset Pricing Models:

A Structural Synthesis
aban elik
Deparment of International Trade and Finance, Yasar University,
Izmir, Turkey. Tel: +90-232-4115343;
Fax: +90-232-4115020. E-mail: [email protected]
ABSTRACT: The purpose of this paper is to give a comprehensive theoretical review devoted to
asset pricing models by emphasizing static and dynamic versions in the line with their empirical
investigations. A considerable amount of financial economics literature devoted to the concept of asset
pricing and their implications. The main task of asset pricing model can be seen as the way to evaluate
the present value of the pay offs or cash flows discounted for risk and time lags. The difficulty coming
from discounting process is that the relevant factors that affect the pay offs vary through the time
whereas the theoretical framework is still useful to incorporate the changing factors into an asset
pricing models. This paper fills the gap in literature by giving a comprehensive review of the models
and evaluating the historical stream of empirical investigations in the form of structural empirical
review.
Keywords: Financial economics; Asset pricing; Static CAPM; Dynamic CAPM; Structural empirical
review
JEL Classifications: G00; G12; G13
1. Introduction
In order to simplify the concept of asset pricing, it needs to give a snapshot of the literature
and a brief overview of perspectives in the field in addition with to describe what it is meant by an
asset. The assets, financial or nonfinancial, will be defined as generating risky future pay offs
distributed over time. Pricing of an asset can be seen as the present value of the pay offs or cash flows
discounted for risk and time lags. However, the difficulties coming from discounting process is to
determine the relevant factors that affect the pay offs. Navigating the market signals and inferring their
impacts on the pay offs are the main task of asset pricing and required to implement the strategic
implications. It is highly important in decision making process at the firm level and also at the macro
level. When we consider asset pricing we often have in mind stock prices. However, asset pricing in
general also applies to other financial assets, for instance, bonds and derivatives, to non-financial
assets such as gold, real estate. Models that are developed in the field of asset pricing shares the
positive versus normative tension present in the rest of economics. When we consider a model1 by
which we predict the future, we usually rely on the underlining assumptions behind it. If the
underlining assumptions are true after evaluation process of normative tests, their predictions should
be true which can be examined through positives tests. However, what we do is in fact not more than
putting everything in one simplified settings.
In most cases, the underlining assumptions of given model do not pass the normative tests.
Even if it is so, we can not hold the impacts of factors affecting the pay offs constant between the two
periods. On the other hand, there is another possibility that the way we describe the world should work
is not overly simplified but the world is wrong that some assets are mispriced and the models need
improvements. Cochrane (2005) states that this latter use of asset pricing theory accounts for much of
its popularity and practical application. Also, and perhaps most importantly, the prices of many assets
1
A model consists of a set of assumptions, mathematical development of the model through manipulations of
these assumptions and a set of predictions (Bodie et al., 2008:309).
International Journal of Economics and Financial Issues, Vol. 2, No. 2, 2012, pp.141-178
142
or claims to uncertain cash flows are not observed, such as potential public or private investment
projects, new financial securities, buyout prospects, and complex derivatives. We can apply the theory
to establish what the prices of these claims should be as well; the answers are important guides to
public and private decisions. Asset pricing theory all stems from one simple concept: price equals
expected discounted payoff. The rest is elaboration, special cases, and a closet full of tricks that make
the central equation useful for one or another application.
The distinctiveness of the study is that this is the first attempt to review literature written on
asset pricing models and the empirical investigation conducted in the form of structural empirical
review. In doing so, the historical perspective of the concept and the place it will take in future are
clarified and the way further researches conducted will be explored.
2. Theoretical Framework
In the scope of the paper, we will explain the models that are classified in the framework of
neoclassical finance2 and evaluate the empirical investigations conducting a structural empirical
review. In neoclassical finance, the models can be grouped into absolute and relative asset pricing
models. We mean by absolute pricing that each asset is priced by reference to its exposure to
fundamental sources of macroeconomic risk. The consumption-based and general equilibrium models
are the purest examples of this approach. The absolute approach is most common in academic settings,
in which we use asset pricing theory positively to give an economic explanation for why prices are
what they are, or in order to predict how prices might change if policy or economic structure changed.
In relative pricing, a less ambitious question is answered. We ask what we can learn about an assets
value given the prices of some other assets. We do not ask where the prices of the other assets came
from, and we use as little information about fundamental risk factors as possible. BlackScholes
(1973) option pricing is the classic example of this approach and its extension Contingent Claim
Analysis (CCA) developed for crediting a countrys default risk. Notwithstanding, there is no solid
line between absolute and relative asset pricing models at least in application3. The problem is how
much relative and how much absolute model may explain asset pricing fundamentals.
Figure 1 outlines the theoretical development and the root of asset pricing in short. The main
distinction starts with the notion that how individual preferences over the distribution of uncertain
wealth are taken place. Financial economists have different views on this ground which can be
classified as neoclassical based4 and behavioral based5. The rational notion behind this paradigm shift
is coming from the way individuals make their decisions. Individuals, in a simplified manner, make
observations, process the data coming out from these observations and come to point in concluding the
results. As Shefrin (2005) pointed out that in finance, these judgments and decisions pertain to the
composition of individual portfolios, the range of securities offered in the market, the character of
earnings forecasts, and the manner in which securities are priced through time. In building a
framework for the study of financial markets, academics face a fundamental choice. They need to
choose a set of assumptions about the judgments, preferences, and decisions of participants in
2
The reason for this limitation is about giving as much intiutive background of central theories as possible while
being informed about the full literature written on asset pricing. We simply cannot explain every single models
developed in the field of asset pricing in a paper.
3
Cochrane (2005) explains that asset pricing problems are solved by judiciously choosing how much absolute
and how much relative pricing one will do, depending on the assets in question and the purpose of the
calculation. Almost no problems are solved by the pure extremes. For example, the CAPM and its successor
factor models are paradigms of the absolute approach. Yet in applications, they price assets relative to the
market or other risk factors, without answering what determines the market or factor risk premia and betas. The
latter are treated as free parameters. On the other end of the spectrum, even the most practical financial
engineering questions usually involve assumptions beyond pure lack of arbitrage, assumptions about equilibrium
market prices of risk.
4
Interested readers may consult Cochrane (2005) for the neoclassical based models whereas Contingent Claim
Analysis (CCA) is not extended to macro level in this book. For useful explanations about CCA applied in
macro level see Gray, et.al., (2007) for theoretical explanations and also Keller, et.al., (2007) for an application
made on Turkey.
5
Interested readers may consult Shefrin (2005) for the behavioral based models. In the scope of the present
paper we will not cover in depth analysis made on the bevarioral contourparts.
Theoretical and Empirical Review of Asset Pricing Models: A Structural Synthesis
143
financial markets. In the neoclassical framework, financial decision-makers possess von Neumann
Morgenstern preferences over uncertain wealth distributions, and use Bayesian techniques to make
appropriate statistical judgments from the data at their disposal.
Figure 1. Stems of Asset Pricing Perspectives
Asset Pricing
Neo-Classical Based
Asset Pricing
Behavioral Based
Asset Pricing
Preferences over uncertain wealth distributions
Von NeumannMorgenstern
theory
Prospect theory
Appropriate statistical judgments
Bayesian techniques
Absolute
Pricing
Relative
Pricing
Heuristics and biases
Behavioral asset pricing
Examples
Examples
Overconfidence
CAPM
CCAPM
OPT
CCA
Overreaction
optimism
On the other spectrum, behavioral finance is the study of how psychological phenomena
impact financial behavior. Behavioralizing asset pricing theory means tracing the implications of
behavioral assumptions for equilibrium prices. Psychologists working in the area of behavioral
decision making have produced much evidence that people do not behave as if they have von
NeumannMorgenstern preferences, and do not form judgments in accordance with Bayesian
principles. Rather, they systematically behave in a manner different from both. Notably, behavioral
psychologists have advanced theories that address the causes and effects associated with these
systematic departures. The behavioral counterpart to von NeumannMorgenstern theory is known as
prospect theory. The behavioral counterpart to Bayesian theory is known as heuristics and biases.
Evidences that are against Efficient Market Hypothesis developed by behavioral finance as follows:
High volume anomaly (Shiller, 1998); Equity Premium Puzzle (Mehra and Prescott, 1985); Volatility
(Shiller, 1998); and Predictability (Fama and French, 1988). One of the central themes of behavioral
finance is the psychological phenomenon people faced with (Shiller, 2003; Thaler, 2000; Kahneman
and Tversky, 1979; Tversky and Kahneman, 1974). These are Overconfidence (Daniel, et.al., 1998;
Lord, et.al., 1979; Daniel and Titman, 1999; Barber and Odean, 1999); Barber and Odean, 2001);
Overreaction (DeBondt and Thaler, 1985, 1987; Optimism (Weinstein, 1980; Taylor and Brown,
1988; Statman, 2002); Availability Heuristic (Barberis and Thaler, 2003); Regret Aversion (Statman,
2002; Bar-Hillel and Neter, 1996; Shefrin and Statman, 1985; Shiller, 1998); Representative Heuristic
(Tversky and Kahneman, 1971; Tversky and Kahneman, 1973) ; Anchoring Heuristic (Tversky and
Kahneman, 1974); Ambiguity Aversion (Ellsberg, 1961; Barberis and Thaler, 2003; French and
144
Poterba, 1991; Baxter and Jermann, 1997; Benartzi, 2001); Impossibility of applying optimization in
practice (Camerer, 1997; Benartzi and Thaler, 2001); Misattribution (Johnson and Tversky, 1983;
Saunders, 1993); Social events (Shiller, 1998; Hong, et.al., 2004; Bikhcandani and Sharma, 2000;
MacGregor, 2002).
More importantly the source of factors that affect the risk premium may also play a role to
classify the models such as the models based on macro economic or firm specific factors depending
upon the underlying assumptions behind. However, there is a clear argument to classify the models on
theoretical ground that generalizing the findings from an empirical investigation is much reasonable
than doing that by data mining. Table 1 reports the main development of Capital Asset Pricing
Models which were explained in the scope of the paper. Starting from Markowitz mean-variance
algorithm, we will explain the models into two main categories as static and dynamic models.
Table 1. Theoretical Development of CAPM
Model
Originator(s)
Markowitz Mean-Variance Algorithm
Markowitz (1952;1959)
Sharpe-Lintner CAPM
Sharpe (1964), Lintner (1965), Mossin (1966)
Black Zero-beta CAPM
Black (1972)
Dynamic Models
Static Models
The CAPM with Non-Marketable Human Capital Mayers (1972)

The CAPM with Multiple Consumption Goods
Breeden (1979)
International CAPM
Solnik (1974a), Adler and Dumas (1983)
Arbitrage Pricing Theory
Ross (1976)
The Fame-French Three Factor Model

Partial Variance Approach Model
Fama and French (1993)

Hogan and Warren (1974) and Bawa and Lindenberg (1977) Harlow
and Rao (1989)
The Three Moment CAPM
Rubinstein (1973), Kraus and Litzenberger (1976)
The Four Moment CAPM
Fang and Lai (1997), Dittmar (1999)
The Intertemporal CAPM
Merton (1973)
The Consumption CAPM
Breeden (1979)
Production Based CAPM
Lucas (1978), Brock (1979)
Investment-Based CAPM
Cochrane (1991)
Liquidity Based CAPM
Acharya and Pedersen (2005)
Conditional CAPM
Jagannathan and Wang (1996)
The main reasons behind the classification7 and formation of the model exhibited in Table 1
are historical development of the advances in asset pricing and theoretical extensions which are built
on Sharpe-Lintner CAPM. To divide the models into framework of static and dynamic structure is
useful on the theoretical ground to demonstrate how to generalize the model from discrete time
process to continuous. The models exhibited in Table 1 are just a model in one way or another to give
a simplified description of complex reality and are not free of incomplete justifications. Even tough a
model that is not an exact description of reality, it is still useful and in most cases better than a simple
average of sample return.
3. Research Methodology
This part is a complemented section to part 2 in which an extensive theoretical review made
on asset pricing models. The empirical research conducted on asset pricing literature is presented here
on systematic based selection criteria so called Structural Empirical Review (SER). In fact, SER is a
technique specifically designed and developed for the present paper to analyze research papers
evidence and interpreting the results on more robust framework. At the first stage, we selected the
6
7
This is Dittmar working paper whereas article form is published in 2002.
Cochrane (2005) induced every asset pricing model into a consumption based asset pricing framework and
explained the dynamics of asset pricing model from different order.
145
most appropriate journals through ISI WEB of Knowledge database and sorted articles based on the
field such as economics, finance in addition with the total number of citations and impact factors of
the journals. In doing this, we reached 43 journals and around 2000 articles (see table 2 for details).
The first elimination criterion we employed is that an article should contain an empirical investigation
of asset pricing models. This elimination reduced the number of articles to 416. At this stage we
explore one of the main concerns for the field of asset pricing that how much attention is paid to asset
pricing models in literature. The question is partially answered by showing the numbers of intercitations among the 416 articles.
Graph 1 shows the total number of citations made by the articles to themselves on annual
basis. For example, there are more than 120 citations made by the articles to the other articles in the
pool in 1996. The most interesting conclusion coming out from the inter-citation statistics is that there
is a decreasing trend on asset pricing models. However, the results have two important constraints: (i)
these articles do contain at least an empirical investigation employed on asset pricing models. There
are many theoretical articles left not to be taken into account for this question. Even in this analysis we
exclude about 1600 articles; (ii) the results are limited to 43 highly cited journals. However, there are a
considerable amount of journals published in field of finance and economics.
Graph 1. Cross citations in reviewed articles
cross citations in reviewed articles
140
120
100
80
60
40
20
The second elimination criterion is that an article should primarily investigate an asset pricing
model and their assumptions or predictions. This elimination criterion reduced the number of articles
to 136 that are deserved to be reviewed for section six (structural empirical review of asset pricing
studies). The main purpose of the review process can be classified as follows: (i) To explore the
process of asset pricing literature; (ii) To examine the results of empirical examination made on static
and dynamic asset pricing models; (iii) To document the estimation techniques employed in the
articles and (iv) To document the main problems developed in the field and their empirical findings.
Table 2 depicts the first 25 finance journals sorted on total citation which also include the first
15 finance journals sorted on impact factor classified by ISI Web of Knowledge. This ensures the
quality of the journals. Table 3 shows the first 20 economics journals based on impact factor classified
by ISI Web of Knowledge. Two journals are classified in both searching process so that in total, 43
highly cited journals are reviewed.
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1974
146
Table 2. Reviewed Journals and the Relevant Statistics (2006): Sorted by impact factor and total citation
Sorted by total citation (2006)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Journal Name
JOURNAL OF ACCOUNTING & ECONOMICS
JOURNAL OF FINANCE
REVIEW OF ACCOUNTING STUDIES
JOURNAL OF FINANCIAL ECONOMICS
JOURNAL OF ACCOUNTING RESEARCH
ACCOUNTING REVIEW
REVIEW OF FINANCIAL STUDIES
JOURNAL OF MONETARY ECONOMICS
JOURNAL OF CORPORATE FINANCE
ACCOUNTING ORGANIZATIONS AND
SOCIETY
FINANCIAL MANAGEMENT
FINANCE AND STOCHASTICS
WORLD BANK ECONOMIC REVIEW
JOURNAL OF FINANCIAL AND
QUANTITATIVE ANALYSIS
JOURNAL OF FINANCIAL INTERMEDIATION
JOURNAL OF MONEY CREDIT AND
BANKING
JOURNAL OF INDUSTRIAL ECONOMICS
MATHEMATICAL FINANCE
AUDITING-A JOURNAL OF PRACTICE &
THEORY
JOURNAL OF FINANCIAL MARKETS
QUANTITATIVE FINANCE
JOURNAL OF RISK AND UNCERTAINTY
JOURNAL OF INTERNATIONAL MONEY
AND FINANCE
CONTEMPORARY ACCOUNTING
RESEARCH
JOURNAL OF BANKING & FINANCE
Total
Data
Interval
1979-2008
1946-2004
1996-2008
1974-2008
1963-2002
1926-2002
1988-2004
1975-2008
1994-2008
Database
sciencedirect
Jstor
Springerlink
sciencedirect
Jstor
Jstor
Jstor
sciencedirect
sciencedirect
1976-2008
1973-2007
1997-2008
1998-2008
sciencedirect
Proquest
ebsco host
abi/inform
10
65
3
0
0
34
1
0
1966-2003
1990-2008
Jstor
sciencedirect
189
3
14
0
1969-2004
1952-2002
1997-2008
Jstor
Jstor
ebsco host
29
10
16
0
1
3
0
0
1995-2008
1998-2008
2001-2008
1988-2008
Na
sciencedirect
informaworld
ebsco host
0
14
9
5
1982-2008
sciencedirect
1984-2007
1977-2008
ebsco host
sciencedirect
Sorted by impact factor (2006)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Journal Name
AMERICAN ECONOMIC REVIEW
ECONOMETRICA
JOURNAL OF POLITICAL ECONOMY
QUARTERLY JOURNAL OF ECONOMICS
JOURNAL OF FINANCIAL ECONOMICS
JOURNAL OF ECONOMETRICS
REVIEW OF ECONOMIC STUDIES
REVIEW OF ECONOMICS AND STATISTICS
ECONOMIC JOURNAL
JOURNAL OF ECONOMIC THEORY
JOURNAL OF ECONOMIC PERSPECTIVES
JOURNAL OF MONETARY ECONOMICS
WORLD DEVELOPMENT
JOURNAL OF ECONOMIC LITERATURE
ECOLOGICAL ECONOMICS
JOURNAL OF PUBLIC ECONOMICS
AMERICAN JOURNAL OF AGRICULTURAL
ECONOMICS
EUROPEAN ECONOMIC REVIEW
RAND JOURNAL OF ECONOMICS
ECONOMICS LETTERS
Total
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4. Theoretical Framework of Static Asset Pricing Models

This section gives short descriptions of static asset pricing models whereas the list is limited to
literature review made in the scope of the paper. Therefore any skipped resemble models within this
category is a reason of our structural literature review constraints.
Sharpe-Lintner CAPM
COV R Xi , RMi
E R X r f
E R M r f
VARR Mi
Where;
......................................................1
COV R Xi , RMi
X
VARRMi
CAPM states that expected return ( E R X ) of an asset is equal to risk free rate ( r f ) plus assets risk
premium ( X E RM r f ). ( E R M is the expected return of hypothetical market portfolio return

which consists of all assets.)
Black Zero-beta CAPM
COV R Xi , R Mi
E R X E R Z
E R M E RZ .........................................2
VARRMi
Following Black (1972), the expression (2) is known as Zero Beta CAPM. Contrary to S-L CAPM, the
difference is that risk free rate is replaced by return of portfolio Z which is uncorrelated with market
portfolio. Portfolio Z technically can be called as companion8 portfolio for market portfolio since it is
uncorrelated. As Black explained that the model in expression (2) can explain why average estimates
of alpha values are positive for low beta securities and negative for high beta securities contrary to the
prediction of S-L CAPM.
The CAPM with Non-Marketable Human Capital
P COVRXi , RMi PH COVRXi , RMi

ERX rf M
ERM rf
PMVARRMi PH COVRMi , RHi
...........................3
Where:
PM : total value of all marketable assets
PH : total value of all nonmarketable assets

RH : one period rate of return on nonmarketable assets
Expression (3) indicates that nevertheless asset pricing is still independent of individual preferences.
Even tough unsystematic risk of the nonmarketable assets will affect individual preferences on
portfolio choices; it is only the systematic, economy-wide, component of non marketable asset returns
that matters. Asset pricing is still affected by covariance risk but it is now an assets covariance with
the market as well as its covariance with the systematic non-market asset return that matters.
This is a technical property of efficient frontier. See Merton (1972) and Roll (1977) for details.
148
The CAPM with Multiple Consumption Goods
ER X r f XM ERM r f XP E RP r f
......................................................4
Where:
XM
VARRP COV RX , RM COV RM , RP COV RX , RP

2
VARRP VARRM COV RM , RP
XP
VARRP COV RX , RP COV RM , RP COV RX , RM

2
VARRP VARRM COV RM , RP
The expression (4)9 depicts the expected return on asset X with market portfolio returns and portfolio
P which can be seen as a perfectly correlated portfolio with a composition of multiple consumption
goods.
International CAPM
COV R X , RWM
E R X r fX
E RWM r fW
VAR
WM
..................................................5
Where
COV RX , RWM
X
VARRWM
X denotes the international systematic risk of security I, i.e. calculated in relation to the worldwide
market portfolio;
r fX denotes the rate of the risk-free asset in the country of security I;
r fW denotes the rate of the average worldwide risk-free asset; and
RWM denotes the return on the worldwide market portfolio.

All the rates of return are expressed in the currency of the asset I country.
Several authors have developed international versions of the CAPM. Among these, we could mention
Solniks model10 (1974a), which is called the International Asset Pricing Model (IAPM). This model
uses a risk-free rate from the country of asset I and an average worldwide risk-free rate, obtained by
making up a portfolio of risk-free assets from different countries in the world. The weightings used are
again the same as those used for the worldwide market portfolio.
Arbitrage Pricing Theory
Ross (1976) introduced The Arbitrage Pricing Theory (hereafter APT) showing how to approximate
equilibrium rate of returns using arbitrage portfolios in the framework of factor models. Factor
models of asset prices postulate that rates of return can be expressed as linear functions of a small
number of factors.
ER X 0 1 X 1
9
X 1, 2,...., n ...............................................................(6.1)
Derivation of expression (4) can be found in Balvers (2001). As Balvers underlined that such case is
overlooked in the literature whereas the dinamic version of the model can be found in Breeden (1979, section 7).
10
See equation 16 in Solnik (1974).
149
where the values of 0 and 1 are the same for every asset. Expression (6.1) holds as a strict equality
only for an exact single-factor model. If risk free asset is present, its return,
Alternatively if the factor model is constructed to explain excess returns,
0 r f
RX rf
rf
, equals
0 .
then 0 0 . When
, the APT predicts:
E R X r f 1 X 1
X 1,2,...., n ............................................................... (6.2)
The weight 1 is interpreted as the risk premium associated with the factor that is, the risk premium
corresponds to the source of the systematic risk. In similar vein, if there are multifactor specification:
E R X r f 1 X 1 2 X 2 .... K XK
X 1,2,...., n ............................(6.3)
The Fame-French Three Factor Model
E R X r f X 1 E RM r f X 2 E SMB X 3 E HML ...........................(7)

Where the model says that the expected return on a portfolio in excess of the risk-free rate [E(Ri) Rf]
is explained by the sensitivity of its return to three factors: (i) the excess return on a broad market
portfolio (RM- Rf); (ii) the difference between the return on a portfolio of small stocks and the return
on a portfolio of large stocks (SMB, small minus big); and (iii) the difference between the return on a
portfolio of high-book-to-market stocks and the return on a portfolio of low-book-to-market stocks
(HML, high minus low). Fama and French (1992; 1993; 1996) assume that the financial markets are
indeed efficient but the market factor does not explain all the risks on its own. They concluded that a
three factor model does describe the assets return whereas they specify that the selection of the factors
is not unique. In addition to the factors that are contained in three factors model they postulate
additional factors that also have explanatory power.
Partial Variance Approach Model
ER X r f
CLPM r f RM , R X
LPM r f RM
ER r
M
.................................................(8.1)
Where
E R X is the equilibrium expected rate of return on asset i;
E R M is the equilibrium expected rate of return on the market portfolio;
LPM r f R M is the lower partial moment of returns below risk free rate on the market portfolio;
CLPM r f R M , R X
is the co-lower partial moment below risk free rate on the market portfolio with
returns on security X.
rf
f RM , R X RM r f R X r f df R X , RM

f R M , R X
is joint probability density function of returns on asset X and on the market portfolio.
Hogan and Warren (1974) and Bawa and Lindenberg (1977) independently developed a mean-lower
partial moment capital asset pricing model (EL-CAPM). In deriving expression (8.1), the target rate in
all cases was set equal to the risk free rate. Systematic risk indicator beta is measured by CLPM/LPM
on the contrary to COV/VAR in S-L CAPM. The authors suggest that the replacement of this change
should be employed when there are distinct and significant differences between the two
measurements. Harlow and Rao (1989) generalize Hogan and Warren (1974) and Bawa and
150
Lindenberg (1977) and attempt for nth order lower partial moment and show in general that in this
scenario a one-beta CAPM obtains as follows:

ER X r f XMLPM n E RM r f ..................................................................(8.2)
Where
XMLPM n
n 1
RM r f R X df R X , RM
RM
n 1
RM df RM
The Three Moments CAPM
R Xi r f c0i c1i RMi r f c 2i RM R M
i .............................................(9)
where the error term, i , is assumed to be homoscedastic, independent of the excess rate of return on
the market portfolio, R M r f , independent of the squared deviation of the excess rate of return on the
market portfolio from its expected value, ( R M R M ) 2 , and to have an expected value of zero. Taking
expected values in (9) and subtracting, to express the quadratic market model in deviation form, then
multiplying both sides by R M R M , taking expected values and dividing through by R2 M yields an
expression for the beta of the ith risk asset:
( R M R M ) 3 . Similarly, multiplying both sides of the deviation form of the quadratic
c c
X
1i
2i
2
RM
market model by ( R M R M ) 2 , taking expected values and dividing through by ( R M R M ) 3 , yields en

expression for the gamma of the ith risk asset:
K 4 2 2
4
M
RM
X c 1i c 2 i
where
K M4 E R M R M
3
R M R M
The forth central moment of the rate of return on market portfolio

By restricting investor preferences, Rubinstein [1973a] and Kraus and Litzenberger 11 [1976] extended
the traditional Sharpe-Lintner mean-variance capital asset pricing model to incorporate the effects of
skewness on equilibrium expected rates of return.
The Four Moments CAPM
E R X r f 1COV R M , R X 2 COV RM2 , R X 3COV R M3 , R .................(10)
Where R M2 R M3 is the square (cube) of the standardized market portfolio return R M ; 1, 2 , 3 are the
market prices of systematic variance, systematic skewness and systematic kurtosis respectively.
Expression (10) is the four moments CAPM which shows that in the presence of kurtosis, the expected
excess rate of return is related not only to the systematic variance and systematic skewness but also to
the systematic kurtosis. The higher the systematic variance and systematic kurtosis, the higher the
expected return. The higher the systematic kurtosis, the lower the expected return. Fang and Lai
(1997) incorporated the effect of kurtosis into the asset pricing model. A four moment CAPM is
derived in which systematic kurtosis in addition to systematic variance and systematic skewness,
contributes to the risk premium of an asset.
11
See equation 6 in Kraus and Litzenberger (1976).
151
5. Theoretical Framework of Dynamics Asset Pricing Models

The Intertemporal CAPM
E R X r f 1 X E R M r f 2 X E R NF r .......... .......... .......... .......... ......(11)

where
1X
X ,Y
X , M X , NF NF ,M
1 NF , M
COV R X , RY
VARRY
AND
AND
2 X
NF , M
X , NF X ,M NF ,M
1 NF ,M
COV RNF , RM
VARRNF VARRM
2
E R NF denotes the expected rate of return of a portfolio that has perfect negative correlation with
the risk-free asset r f . All the rates of return are used in this model are continuous rates. If the riskfree rate is not stochastic, or if it is not correlated with the market risk, then the third fund disappears,
X , NF NF , M 0 .. We then come back to the standard formulation of the CAPM, except that
the rates of return are instantaneous and the distribution of returns is lognormal instead of being
normal.
The Consumption CAPM
E R X r f X ,C E RC r f .......... .......... .......... .......... .......... .......... .......... ...(12)

Where
ERC is return obtained by creating a mimicking portfolio with stochastic return
X ,C
COV R X , RC
VARRC
Breeden (1979) derives a single beta asset pricing model in multi-good, continuous-time model with
uncertain consumption goods prices and uncertain investment opportunities. In Consumption CAPM12,
the equity premium is proportional to a single beta, which is the covariance with consumption (usually
replaced with consumption growth per capita in empirical tests) rather than to the market portfolio.
Production Based CAPM
E RtX1 rt f Xy ( E Rty1 rt f ) .................................................(13)

where
iy Covt (rt y1 , rti1 ) / Vart (rt y1 )

Here rt y1 may represent either the return on an asset perfectly correlated with aggregate production or
the growth rate of aggregate production itself13. Lucas (1978) examined the stochastic behavior of
equilibrium asset prices in a one-good, pure exchange economy with identical consumers. The single
good in this economy is (costlessly) produced in a number of different productive units; an asset is a
claim to all or part of the output of one of these units. Productivity in each unit fluctuates
stochastically through time, so that equilibrium asset prices will fluctuate as well. Lucass objective
12
13
See equation 21 in Bredeen (1979).

Balvers (2001) derives the expression (13) based on the equation 6 in Lucas (1978).
152
was to understand the relationship between these exogenously determined productivity changes and
market determined movements in asset prices and usually used to explain the equity premium puzzle14
Investment-Based CAPM
g t 1
g I t ..................................................................(14)
R I s t 1 f k t 1 k
g I t 1
Where
t
t 1
R I is the investment return from state s to state s
f (.) is production function

g (.) is function for adjustment costs to investment
t
The notation (t) means evaluated with respect to the appropriate arguments at time t in state s and
subscript denote partial derivatives. Cochrane derived the expected return and investment relationship
in a non standard asset pricing equation with functional form. Cochrane (1991) obtained equation 15
(14) in the specific context of a complete markets economy. It can be interpreted as the physical
investment return of a firm. It is obtained from a within-firm type of arbitrage: invest in the current
period and then withdraw enough investment in the next period to keep the capital stock for future
periods equal to what it would have been without the current period investment; the net payoff per unit
extra investment in the current period is the investment return.
Liquidity Based CAPM
E RtX rt f E ctX 1 X 2 X 3 X 4 X
Where
1X
4X
COV RtX , RtM Et 1 RtM

COV R , c E c
VARR E R c E c
COV c E c , R E R
VARR E R c E c
RtM
VAR
E t 1 RtM
COV ctX Et 1 ctX
2X
VAR RtM Et 1 RtM
3X
....................................(15)
ctM Et 1 ctM
, ctM E t 1 ctM
ctM Et 1 ctM
X
t
M
t
X
t
M
t
M
t
M
t 1 t
X
t 1 t
M
t 1 t
E t E RtM ctM r f
t 1
M
t
M
t
M
t
M
t
M
t
M
t 1 t
M
t 1 t
t 1
Acharya and Pedersen (2005) present a simple theoretical model that helps to explain how asset prices
are affected by liquidity risk and commonality in liquidity. The model provides a unified theoretical
framework that can explain the empirical findings by pricing market liquidity, average liquidity, and
liquidity that co-moves with returns and predicting future returns. In the liquidity based CAPM16, the
expected return of a security is increasing in its expected illiquidity and its net beta, which is
i
proportional to the covariance of its return, r ; net of its exogenous illiquidity costs, c i , with the
14
Mehra and Prescott use the Lucas Model to explain the theoretical discussion behind the puzzle. (cited in
Constantinides, et.al., (2003, chapter 14))
15
See equation 12 in Cochrane (1991) in addition with some specific functional form given for operational
purposes in emprical tests.
16
See equation 8 for the conditional version of expression (5) and equation 12 for unconditional version, the one
explained here, in Acharya and Pedersen (2005).
153
market portfolios net return r M c M . The net beta can be decomposed into the standard market beta
and three betas representing different forms of liquidity risk. These liquidity risks are associated with:
(i) commonality in liquidity with the market liquidity, COV c i , c M ; (ii) return sensitivity to market
liquidity, COV r i , c M ; and, (iii) liquidity sensitivity to market returns, COV c i , r M .

Conditional CAPM
E R Xt t 1 0t 1 1t 1 Xt 1 .........................................................................(16.1)
where
Xt 1 is the conditional beta of asset i and in each period t,

Xt 1
COV R Xt , R Mt t 1
VARR Mt t 1
0t 1 is the conditional expected return on a zero-beta portfolio,

1t 1 is the conditional market risk premium.
The subscript t indicates the relevant time period. R Xt denotes the gross return on asset X in period t
and in similar manner, R Mt is the gross return on the aggregate wealth portfolio of all assets in the
economy in period t. Explaining cross sectional variations in the unconditional expected return on
different asset, take the unconditional expectation of both sides of expression (16.1):
E R Xt 0 1 X COV 1t 1 , Xt 1 ...........................................................(16.2)
where
0 E0t 1 , 1 E1t 1 and X E Xt 1

Here, 1 -lamdal is the expected market risk premium, and X is the expected beta. If the covariance
between the conditional beta of asset X and the conditional market risk premium is zero (or a linear
function of the expected beta) for every arbitrarily chosen asset X, then expression (16.1) resembles
the static CAPM, i.e., the expected return is a linear function of the expected beta. One of the
assumptions of S-L CAPM is that the behavior of investors is estimated for one period. This is why it
is necessary to make certain assumption that the betas of assets remain constant through the time in
empirical examination of the CAPM. Jagannathan and Wang (1996) propose this model that includes
this assumption for the reason that the relative risk of a firm's cash flow is likely to vary over the
business cycle.
154
6. Structural Empirical Review of Asset Pricing Studies

Code
Reference
Research Question
Can a single world index model give a
realistic description of the international
structure of asset prices?
What is the impact of the existence national
factors in returns generating process?
Data-[Time
period]
US and European
data [1966
1971]
16 National
Market Indices and
30 International
Market Indices
[1959 1973]
US and 7
European countries
[1966 1971]
Model
Estimation
Techniques
OLS
Conclusion
CAPM and
IAPM
OLS
Only a small proportion of the variance of national portfolios is

common in an international context which gives rise to
considerable risk reduction through international dimension.
CAPM
OLS
The whole evidence does not show substantial differences

between the United States and the four major European
markets. Some cases can be made for the three smaller markets
being less efficient.
The conditional predictions of the CAPM provide
nonstationary, biased estimates of actual returns. The singlefactor market model does not properly adjust for market-wide
effects in assessing security performance.
As soon as the MV framework is used on ex post data, the
separation property will hold internationally even if all the data
come from tables of random numbers and no one holds foreign
stocks.
Insiders can outperform the market in their stock selections.
Solnik (1974b)
CAPM and
IAPM
Lessard (1974)
Pogue and
Solnik (1974)
How market model performs on European

common stocks returns?
Pettit and
Westerfield
(1974)
Can CAPM explain the structure of

conditional predicted portfolio returns?
US Data [1926
1968]
CAPM
OLS
Solnik (1977)
US and 7
European countries
[1966 1974]
IAPM
OLS
Finnerty (1976)
OLS
Griffin (1976)
US Data [1969
1972]
US Data [1953
1973]
CAPM
CAPM
OLS
Arbel, et.al.,
(1977)
Is it very unlikely that an empirical meanvariance analysis will ever be able to

discriminate between the various views of
the world?
Do the insiders earn more than the market
on average?
Are there any differences in the association
between each informational variable and
security returns?
What is the relationship between default
risk and return on equity?
US Data [1965
1973]
CAPM
OLS
Lee (1977)
How possible factors affecting the secondpass regression results in capital asset
pricing?
US Data [1965
1972]
CAPM
MLE
10
Levhari and
Levy (1977)
How deviation from the "true" horizon

causes a systematic bias in the regression
coefficient?
US Data [1948
1968]
CAPM
OLS
An international market structure of price behavior appears to

exist.
The behaviour of the cumulative average residual-per-share,

dividends-per-share and forecasts of earnings-per-share on the
assessment of expected return is significant.
Results support the usefulness of the capital asset pricing model
and suggest that the magnitude of the cost of default when
combined with the probability of occurrence is insignificant as
an independent variable in generating stock returns.
The functional form, the skewness effect, and the change of
market condition are the most important factors in affecting the
empirical conclusions in testing the bias of composite
performance measure and the risk-return relation.
The investment horizon for which data are collected plays a
crucial role and has a great impact on both the regression
coefficients and the performance indices.

Code Reference
Research Question
11
Are betas stationary?
12
Brenner and
Smidth (1977)
Lloyd and
Shick (1977)
Is Stones Two-Index Model of returns

valid to explain cross-sectional excess
returns?
Is CAPM predictive power of practical use
in evaluating the returns to equity of public
utility?
Data-[Time
period]
US Data [1963
1968]
US Data [1969
1972]
CAPM
Estimation
Techniques
OLS
Stones
Two- Index
Model
CAPM
OLS
13
Goldberg and
Vora (1977)
14
Friend, et.al,
(1978)
Can direct test decrease the gab between

theory and evidence?
US Data [1974
1977]
CAPM
OLS
15
Goldberg and
Vora (1978)
How CAPM performs if spectral analysis is

used in testing procedures?
US Data [1926
1972]
CAPM
OLS and
spectral analysis
16
Grauer (1978)
How to measure aggregate or composite

individuals utility function based on the
observed market behavior of investors.
US Data [1934
1971]
CAPM
(utility
based)
OLS
17
Bachrach and
Galai (1979)
Is the economic rationale for the existence

of specific characteristics for groups of
securities in "low" and "high" price ranges?
US Data [1926
1968]
CAPM
OLS
18
Fowler,
et.al., (1979)
How residual behavior exists?
US Data [1965
1976]
CAPM
OLS
19
Baesel and
Stein (1979)
Brown,
(1979)
Do insiders earn more than uninformed

investors?
Are the market imperfection
(autocorrelation) associated with
misspecification of the CAPM?
Is Fama-Macbeth procedure efficient than
Random Coefficient Regression?
US Data [1968
1972]
US Data [1955
1973]
CAPM
OLS.
CAPM
OLS
US Data [1935
1974]
CAPM and
Zero beta
CAPM
OLS and
Random
coefficient
regression
20
21
Schallheim and
Demagistris
(1980)
US Data [1936
1972]
Model
155
OLS (Bivariate
spectral
analysis)
Conclusion
The slight difference between models (employed) that does exist
tends to favor the hypothesis of constant beta coefficients.
The results are mixed, but generally favor the model.
Portfolio returns were independent of time. SIM (Single Index

Model) worked well in explaining the returns on the control
securities for all regulated firms, electric, and combination gas
and electric portfolios, but did not explain the returns on any of
the regulated firm portfolios themselves.
Findings are inconsistent with Sharpe-Lintner theory if it is
appropriate to use for empirical testing the one factor returngenerating function relating actual to expected return.
the market "index" does not perfectly explain individual portfolio
movements for all portfolios and that despite cyclical betas that
are fairly stable over time, the true value of beta appears to be
different for cycles of differing durations.
There was a slight indication that the more risk averse models
better described security pricing.
Low price stocks are riskier than high price stocks. In the long
run, the compensation is the same, on the average, for the two
mutually exclusive price groups. Only part of the relatively high
average rate of return on the low price stocks can be explained
by their relatively high systematic risk.
It is found that there is evidence of heteroscedasticity and low R2
and a noticeable dependence of these with frequency of trading
in the underlying stock.
. Both ordinary insiders and bank directors earned positive
premium returns relative to an uninformed trading strategy.
There is an association between the level of autocorrelation and
the level of beta. The CAPM is the least misspecified in those
subsamples where autocorrelation is essentially neutral.
The simple Fama-MacBeth (averaging procedure) appears to be
sufficient. However the evidence exhibited by the percentage
differences suggests that the RCR procedure does make a
difference especially over the long periods.
Code Reference
Research Question
22
Scott and
Brown (1980)
Are betas stable?
23
Levy (1980)
24
156
Data-[Time
period]
US Data [1967
1971]
Model
How CAPM performs with the data taken

from Israel market?
Israel Data
[1965 1980]
CAPM
OLS
Friend and
Westerfield
(1980)
How CAPM and Three Moment CAPM

perform?
US Data [1968
1973]
OLS
25
Cheng and
Grauer (1980)
How CAPM perform under the different

tests?
US Data [1926
1977]
CAPM,
Three
Moment
CAPM
CAPM
26
Barry (1980)
How CAPM performs on the farm real

estate firms?
US Data [1950
1977]
CAPM
27
Roll and Ross

(1980)
How APT performs?
US Data [1962
1972]
APT
OLS and
cochrane-Orcutt
regression
Factor analysis
and OLS
28
Merton (1980)
How the three models developed in the

paper estimate the expected return on the
market?
US Data [1926
1978]
Three
Empirical
(unspecifie
d) models
OLS
29
Miller and
Gressis (1980)
How to dealing with risk-return relationship

in the presence of nonstationarity?
US Data [1973
1974]
CAPM
OLS
30
Collins And
Rozef (1981)
How common stock performance of firms

are affected in the fight of modified investor
theory, contracting cost theory and
estimation risk theory?
US Data[1976
1977]
CAPM
(CAR)
OLS
CAPM
Estimation
Techniques
OLS and
modified OLS
OLS and (Orcutt

regression)
Conclusion
Results demonstrate that changes in estimated betas are
significantly associated with changes in the product of the
estimates of autocorrelations for residuals and the estimates for
intertemporal market-residual covariances.
The CAPM explains about 40 percent of the variability of the
average rates of return; the coefficients of the regression are not
far from the observed variables.
The Kraus-Litzenberger attempt to develop and substantiate a
modified form of the Sharpe-Lintner CAPM is not successful.
There are predominantly statistically significant trends in the

estimated values of the intercept as regressors are added. There
is a statistically significant increase in the adjusted coefficient of
determination as the number of regressors increases.
For the period, returns data, and market index, investments in
farm real estate by well-diversified investors appeared to
outperform the market and most individual assets too.
The empirical data support the APT against both an unspecified
alternative-a very weak test-and the specific alternative that own
variance has an independent explanatory effect on excess
returns.
First, it has been shown that in estimating models of the expected
return on the market, the non-negativity restriction on the
expected excess return should be explicitly included as part of the
specification. Second, estimators which use realized return time
series should be adjusted for heteroscedasticity.
Results indicate the existence of a good deal of nonstationarity in
the risk-return relationships. When there are changes in beta,
investors are interested in whether such changes have beneficial
or perverse effects on a shareholder's wealth.
The FASB's proposal had a measurable negative effect on the
equity values of affected firms. The set of variables which was
hypothesized to measure the increased contracting costs and/or
estimation risk associated with the FASB's proposed elimination
of FC accounting was found to explain a significant proportion
of the cross-sectional variation in abnormal return performance
of our sample firms in the two weeks centered on the Exposure
Draft issuance.

Code Reference
Research Question
31
Oldfield and
Rogalski
(1981)
Brewer (1981)
33
157
Estimation
Techniques
Factor analysis,
OLS
Conclusion
CAPM
OLS
Multi
factor
model
CAPM
OLS
There seems to be no statistical difference in the risk-adjusted

performance of MNC and NATL common stocks. MNCs provide
no discernable advantage over nationals with respect to an
investor's quest for the risk/return benefits of international
portfolio diversification
The returns from stock groups such as Farrell's stables-cyclicaland-growth were shown to relate to returns in the Government
bond market and to corporate bonds with default risk
The evidence indicates that NYSE-AMEX stock portfolios with
widely different estimated betas possess statistically
indistinguishable average returns.
Model
How the factors that affect treasury bill

influence the common stocks?
Data-[Time
period]
US Data [1964
1979]
Is there any difference in the SMLs for

MNCs and NATLs?
US Data [1963
1975]
Fogler, et.al.,
(1981)
If there are multiple factors what might they

be?
US Data [1959
1977]
34
Reinganum
(1981)
Are variations in estimated betas

systematically related to variations in
average returns?
US Data [1926
1979]
35
Reinganum
(1981)
Is CAPM misspecified or market

inefficient?
US Data [1962
1978]
CAPM
OLS+ Scholes
Williams and
Dimson
estimates
OLS,
36
Reinganum
(1981)
Does APT explain the differences in

average returns of firms?
US Data [1962
1978]
APT
Factor analysis
37
Weinstein
(1981)
US Data [1962
1974]
CAPM
OLS,
38
Roll (1981)
Do bonds exhibit systematic risk/to which

extent interest rate and default risk explain
cross sectional variation of bonds risk?
Do small firms have higher returns even
when their measured risk is no greater than
that of large firms?
US Data [1962
1977]
CAPM
OLS,
autocorrelation
regression +
Dimson beta
estimator
32
APT
Treasury bill returns provide a source for identifying statistical

factors that influence common stock returns.
The evidence in this study strongly suggests that the simple oneperiod capital asset pricing model is misspecified. The set of
factors omitted from the equilibrium pricing mechanism seems to
be more closely related to firm size than E/P ratios.. The
misspecification, however, does not appear to be a market
inefficiency in the sense that abnormal returns arise because of
transaction costs or informational lags.
The evidence in this paper indicates that a parsimonious APT
fails this test. That is, portfolios of small firms earn on average
20% per year more than portfolios of large firms, even after
controlling for APT risk.
Beta and interest rate risk are positively related. The bond
market is amenable to the same types of analyses as have been
done in recent years on the stock market.
The mis-assessment of risk has the potential to explain why small
firms, low price/earnings ratio firms, and possibly high dividend
yield firms display large excess returns (after adjustment for
risk). Positive auto-correlation induced in portfolios of such
firms because of infrequent trading results in downward biased
measures of portfolio risk and corresponding overestimates of
"risk adjusted" average returns.
Code Reference
Research Question
39
Grauer (1981)
40
158
Model
Do mean variance and Linear Risk

Tolerance CAPM distinguishable?
Data-[Time
period]
US Data [
[1934 1971]
CAPM
Estimation
Techniques
OLS
Banz (1981)
Are returns and market value of common

stocks related?
US Data [1926
1975]
CAPM
OLS and GLS
41
Chen (1981)
Do betas follow stationary process over

time?
US Data [1966
1975]
CAPM
OLS ,Optimal
Bayesian
estimator
42
Figlewsk
(1981)
Do informational effects of restrictions

affect the stock returns?
US Data [1973
1979]
CAPM
OLS
43
Downes and
Heinkel (1982)
Are the entrepreneurial ownership retention

hypothesis and the dividend signaling
hypothesis related to firm value?
US Data [1965
1969]
Leland and
Pyle model
OLS
44
Alexander,
et.al., (1982)
Can the systematic risk of mutual funds

theoretically be modeled?
US Data [1965
1973]
CAPM
45
Price, et.al.,
(1982)
Are there systematic differences in the two

risk measures?
US Data [1927
1968]
46
Reinganum
(1982)
Is average return of small firm statistically

different than big firms?
US Data [1963
1970]
CAPM and
lower
partial
CAPM
CAPM
Regression,
Markov process,
LamotteMcwhorter
OLS
OLS and
Dimson beta
Conclusion
At the macro level, the primary results are: (1) judged by the
generalized SML tests, the MV and a very wide variety of power
utility LRT models are indistinguishable; (2) in a pragmatic but
somewhat limited sense, in light of Roll's critique, the results are
not affected by the choice of either an equally or value-weighted
proxy for the market portfolio.
The CAPM is misspecified. On average, small NYSE firms have
had significantly larger risk adjusted returns than large NYSE
firms over a forty year period.
The OLS method is not an appropriate method to be used to
estimate portfolio residual risk if the beta coefficient is changing
over time. The use of the OLS method will overestimate portfolio
residual risk and lead to the incorrect conclusion that larger
portfolio residual risk is associated with higher variability in
beta coefficient.
The hypothesis that prices of stocks for which there was
relatively more adverse information among investors would tend
to be too high, received empirical support from the tests
conducted in the paper.
Results offer strong support for the LP hypothesis. Firms in
which entrepreneurs retain high fractional ownership do indeed
have higher values, as the theory predicts. On the other hand, the
BH dividend signaling hypothesis is rejected by the data. The
significant negative role found for dividends suggests that this
may be attributable to omitted, not readily observable, variables
from the valuation equation
Mutual fund systematic risk theoretically can be modeled as a
first - order Markov process when fund managers do not actively
engage in timing decisions.
At any rate, the results do not allow us to rest easy with the
assumption that CLPM/LPM = COV/V, and hence that the latter,
more familiar, measure can be used as our measure of systematic
risk.
The test results indicate that precise estimates of betas for small
firms may be difficult to obtain. Nonetheless, even the highest
point estimate for the beta of the small firm portfolio did not
seem to account for its superior performance.

Code Reference
Research Question
47
Gibbons
(1982)
How a newly developed methodology

performed in application.
48
Casabona and
Vora (1982)
49
Standish and
Swee-Im Ung
(1982)
Klemkosky and
Jun (1982)
Does the adjusted risk premium perform

better than conventional use at risk
premium in empirical test of CAPM
Do corporate signaling impact the stock
price?
50
159
Data-[Time
period]
US Data [1926
1975]
Model
CAPM
Estimation
Techniques
OLS
US Data [1926
1972]
CAPM
OLS
CAPM
OLS
Are there any relationship between

monetary changes and CAPM parameters?
UK (United
Kingdom)
[1964 1973]
US Data [1954
1980]
CAPM
OLS
51
Whaley and
Cheung (1982)
How earning announcements are anticipated

in stock price?
US Data [1973
1977]
CAPM
OLS
52
Stambaugh
(1982)
How CAPM performs when different sets

of asset return included in market portfolio?
US Data [1953
1976]
CAPM
OLS and MLE
53
McDonald
(1983)
What is the functional form of CAPM and

their effects on empirical evidence?
US Data [1973
1979]
CAPM
MLE
54
Carter, et.al.,
(1983)
Is future market efficient?
US Data [1966
1976]
CAPM
OLS, GLS
55
Keim (1983)
Are size related anomalies and stock return

seasonality persisted and stable over time ?
US Data [1963
1979]
CAPM
OLS, scholes
williams beta,
dimson beta
56
Dimson and
Marsh (1983)
Are the UK risk measures stable over time ?
UK Data [1955
1979]
CAPM
OLS, Adjusted
betas
Conclusion
With no additional variable beyond, the substantive content of
the CAPM is rejected for the period 1926-1975 with a
significance level less than 0.001.
The use of conventional risk premiums, calculated in the manner
suggested by Roll may cause significant bias in the estimates of
the parameters of the market model.
Results indicate that, on average, there were positive unexpected
returns from investment in the sample of British companies which
announced revaluations of fixed assets.
The wealth effect and the return variability effect of money are
shown to be the two important channels of the monetary impact
on the market risk premium for three representative classes of
utility functions.
The evidence reported in this study indicates that the CBOE is an
efficient market. No profits net of transaction costs can be earned
in the option market by trading on the basis of firms' earnings
announcements.
Inferences based on the most inclusive set of assets - common
stocks, bonds, and preferred stocks - reject the Sharpe-Lintner
version of the CAPM but do not reject the more general Black
version.
For the researcher and the practitioner, the findings of this study
support the validity of applying the linear or logarithmic CAPM
in estimating systematic risk, versus a methodology that could
vastly complicate the estimation process.
For an efficient portfolio and an application of the CAPM to
futures contracts that allows for changing speculative position,
our analysis supports the generalized Keynesian theory of
normal backwardation.
Evidence indicates that daily abnormal return distributions in
January have large means relative to the remaining eleven
months, and that the relation between abnormal returns and size
is always negative and more pronounced in January than in any
other month even in years when, on average, large firms earn
larger risk-adjusted returns than small firms.
Thin trading can lead to serious bias in risk measures.
Furthermore, since trading frequency is stable over time, this
bias will be persistent, and will impart a spurious stability to
estimates of beta and other risk measures.
Code Reference
Research Question
57
Elton and
Gruber (1983)
58
Hansen and
Singleton
(1983)
Does the impact of dividend yield explain

the deviations from returns CAPM
produced?
How intertemporal relation of asset returns
exists?
59
Kryzanowski
and Chau To
(1983)
60
160
Data-[Time
period]
US Data [1927
1976]
Model
US Data [1959
1979]
CAPM
MLE
Is there a common factor affecting stock

returns?
US Data [1948
1977]
APT
Chen, Nai-Fu
(1983)
How APT and CAPM perform?
US Data [1963
1978]
CAPM and
APT
Factor analysis
(Raos factor
analysis alpha
factor analysis)
Factor analysis,
OLS
61
Schultz (1983)
Is transaction cost important factor for the

anomaly of small firm effect?
US Data [1962
1978]
CAPM
Dimson beta
62
Brown and
Kleidon (1983)
Do small firms have tended to yield returns

than those predicted by traditional CAPM?
US Data [1967
1975]
CAPM
OLS,SURM
63
Stambaugh
(1983)
How the excluded return in indexes for real

estate and durables estimated and affect the
mean variance theory?
US Data [1953
1976]
CAPM
MLE
Zero beta
CAPM
Estimation
Techniques
OLS
Conclusion
There seems to be persistent patterns in excess returns which are
related to dividend yield. Some of these differences may be due to
tax effects. Others have not as yet been adequately explained.
Maximum likelihood estimation of the free parameters of most of
the monthly models yielded point estimates of the coefficients of
relative risk aversion that were between zero and two. The test
statistics provided little evidence against the models using the
value-weighted return on stocks listed on the New York
exchange.
It seems reasonable to hypothesize that a factor structure of five
factors is sufficient from an economic perspective.
Based on the empirical evidence gathered so far, the APT cannot

be rejected in favor of any alternative hypothesis, and the APT
performs very well against the CAPM as implemented by the
S&P 500, value weighted, and equally weighted indices.
Therefore, the APT is a reasonable model for explaining crosssectional variation in asset returns
The anomalous behavior of small firm returns cannot be
explained solely on the basis of differences in transaction costs
between small and large firms.
There are three new results here concerning size-related
anomalies in stock returns. First, we have shown that the relation
between excess returns and firm size can be regarded as linear in
the log of size. Second, the ex ante excess returns attributable to
size are not constant through time. Third, different estimation
methodologies can lead to different conclusions about the size
effects.
None of the statistics rejects linearity at conventional
significance levels, and the statistics and p-values are quite
similar across indexes.

Code Reference
Research Question
64
Bey (1983)
Is CAPM in the form of market model

stationary over time?
65
Basu (1983)
66
161
Data-[Time
period]
US Data [1960
1979]
Model
How is the empirical relationship among

earnings yield, firm size and returns of
common stocks?
US Data [1962
1978]
CAPM
OLS , Dimson
beta
Brown and
Weinstein
(1983)
Are the common factors that affect stocks

returns constant over time?
US Data [1962
1972]
APT
67
Cho, et.al.,
(1984)
How zero beta and APT performs?
US Data [1973
1980]
Zero-beta
CAPM,AP
T
Factor analysis
(Jreskog
algorithm)
OLS,GLS
Factor analysis
,GLS
68
Cho (1984)
Is APT valid model?
US Data [1962
1982]
APT
GLS, factor
analysis (interbattery)
69
Bower, et.al.,
(1984)
Dhrymes, et.al.,
(1984)
Which model is better to estimate the

expected returns: APT or CAPM?
Are the numbers of factor increasing as the
numbers of securities increase in testing
APT through factor analysis?
Is there a linear relationship between risk
premiums and consumption beta?
US Data [1971
1979]
US Data [1962
1972]
APT and
CAPM
APT
OLS (Theil
measure)
Factor analysis
US Data [not
stated]
C-CAPM
OLS
70
71
Hazuka (1984)
CAPM
Estimation
Techniques
OLS
Conclusion
The behavior of the market model for individual securities,
utilities, and non-utilities varied considerably over time and was
dependent on the time period studied.
The empirical findings reported in this paper indicate that, at
least during the 1963-80 time period, the returns on the common
stock of NYSE firms appear to have been related to earnings
yield and firm size. In particular, the common stock of high E/P
firms seem to have earned, on average, higher risk-adjusted
returns than the common stock of low E/P firms. On the other
hand, while the common stock of small NYSE firms appear to
have earned considerably higher returns than the common stock
of large NYSE firms, the size effect virtually disappears when
return are controlled for differences in risk and E/P ratios.
With very many observations it is possible to reject any
hypothesis at one's favorite level of statistical significance. When
we adjust the size of the test to take this into account, our results
are consistent with the three factors APM.
In two simulation experiments, we find that while Roll and Ross
(1980) procedure has a slight tendency to overstate the number
of factors at work in the market, this tendency cannot account for
the large number of factors they found in their original article.
Results indicate that there are five or six inter-group common
factors that generate daily returns for two groups and that these
inter-group common factors do not depend on the size of groups.
Also, the APT could not be rejected in the sense that the risk-free
rate and the risk premium are the same across groups and that
the risk-free rate is different from zero.
APT does do better CAPM in explaining and conditionally
forecasting return variations through the time and across assets.
Results show that how many factors one "discovers" depends on
the size of the group of securities one deals with.
Both the intercept and the slope coefficients were significantly
positive, as the theory predicted; however, the magnitude of the
intercept was smaller and that of the slope greater than
predicted.
Code Reference
Research Question
72
Dhrymes, et.al.,
(1985)
73
162
Model
Can the ability of risk measures from one

period to another explain returns?
Data-[Time
period]
US Data [1962
1981]
Amsler and
Schmidt (1985)
How artificial returns work in context of

CAPM test?
Artificial
(random) data
CAPM
Monte Carlo
experiment
74
Brown and
Gibbons (1985)
Which estimation method, parametric or

non-parametric is better?
US Data [1926
1981]
Utility
based asset
pricing
models
Method of
moment and
parametric
estimation
75
Barone-Adesi
(1985)
How arbitrage equilibrium with skewed

asset returns existed?
US Data [1926
1970]
Three
moment
CAPM
OLS (likelihood
ratio)
76
Ang and
Peterson (1985)
How is the role of yield (dividend) in

explaining stock returns?
US Data [1973
1983]
CAPM(afte
r tax
adjusted )
Maximum
likelihood
77
Shanken (1985)
How zero beta CAPM performs?
US Data [1959
1971]
Zero-beta
CAPM
OLS,+ GLS
APT
Estimation
Techniques
Factor analysis
(GLS)
Conclusion
Test results appear to be extremely sensitive to the number of
securities used in the two stages of the tests of the APT model.
New tests also indicate that unique risk is fully as important as
common risk. While these tests have serious limitations, they are
inconsistent with the APT.
The main results of our experiment are clear and easily
summarized: 1. The Wald test is unreliable. 2. Shankens tests
are unreliable. 3. The LR test is better than the tests in 1 and 2,
but it is still unreliable unless the sample size is very large. Its
problem is that it rejects the null hypothesis too often (when it is
true). 4. The LM test is considerably better than the tests in 1, 2
and 3. It is reasonably reliable except when T is small or K is
relatively large, in which case it exhibits a tendency to reject the
null hypothesis too seldom. 5. Shankens CSR test and Jobson
and Korkies LR test are quite reliable under all circumstances
which we consider. 6. There is no basis in our results to prefer
the CSR test to the LR test, or vice versa.
The results from the overall period suggest no statistically
significant departure from log utility. The economic distinction
between RRA equal to one versus (say) two may not be very
important given the behavior of an individual to a timeless
gamble.
Empirical tests try to relate ex post returns to ex ante
expectations. Their results are, therefore, sensitive to the
specification of this link. With this caveat, it appears that the
arbitrage equilibrium associated with the quadratic market
model is not a complete description of empirical security returns,
even though this arbitrage model appears to be of some utility in
understanding security pricing.
Results from the estimation of the after-tax CAPM indicate a
general positive and significant relationship between return and
yield, although there are years in which the relationship is
insignificant.
The CRSP equally weighted index is inefficient, but that the
inefficiency is not explained by a firm size-effect from February
to December.

Code Reference
Research Question
78
Yagil (1985)
79
80
163
Model
Is Index-Linked bond efficient in the

content of CAPM?
Data-[Time
period]
Israel Data
[1981 1984]
Chan, Chen
and Hsieh
(1985)
Is there a firm size effect in the context of

multifactor models?
US Data [1953
1977]
Best and
Grauer (1985)
Gibbons and
Ferson
(1985)
How the relation between MV based CAPM

and observed market value weights is?
How financial models perform when risk
premium is relaxed to be changing?
US Data [1935
1979]
US Data [1962
1980]
Multifactor
pricing
models
(CAPM)
CAPM
82
Gultekin and
Rogalski
(1985)
How is the bonds risk evaluated in context

of APT and CAPM in addition with the
interest rate?
US Data [1960
1979]
APT,
CAPM
83
Jagannathan
(1985)
Can future prices be modeled by

consumption based intertemporal model?
US Data [1960
1978]
CCAPM
OLS + factor
analysis
+seemingly
unrelated
regression +
GLS +
GMM
84
Swidler (1985)
OLS
Sweeney and
Warga (1986)
US Data [1982
1983]
US Data [1960
1979]
CAPM
85
How is the role of analyst forecasts taken

place in the context of CAPM?
Are the firms required to pay investors ex
ante premium for bearing this risk of
interest-rate changes?
APT and
CAPM
MLE
81
CAPM
CAPM
,multi
factors
Estimation
Techniques
OLS
OLS
Mean variance
optimization
OLS
Conclusion
The empirical results indicated that the model presented was
somewhat successful in identifying incorrectly valued index
bonds, implying that this market is not perfectly efficient, at least
in the case of the Israeli index bond market.
Among the economic variables included, the measure of the
changing risk premium explained a large portion of the size
effect.
The result highlights a number of inconsistencies involved in MV

modeling.
Asset pricing models can be estimated and tested without
observing the market portfolio or state variables. Avoiding a
specification of these is a by-product of relaxing the assumption
that risk premiums are constant. While changing risk premiums
does require a model for conditional expected returns, a
regression model permits standard specification tests and is
robust to missing information.
It is found that at least two factors are linearly related to mean
bond portfolio returns. We did not, however, uncover a linear
relation between mean bond returns and various portfolio
proxies. Furthermore, multivariate test results are not supportive
of the APT or the Sharpe Lintner and Black versions of the
CAPM.
The model was rejected. It is possible that the asymptotic
inference theory was not justified in our case due to the small
sample size. It is also possible that some of the underlying
assumptions were not satisfied.
Firms neglected by analysts have greater divergence of opinion
about the mean forecast.
Changes in government bond yields clearly affect ex post returns
to electric utilities, and that this phenomenon is concentrated to a
much larger extent in this particular industry than in NYSE firms
as a whole.
Code Reference
Research Question
86
Korkie (1986)
Is size anomaly related to a sample

inefficient index?
Data-[Time
period]
US Data [1951
1980]
87
Dimson and
Marsh (1986)
Mankiw and
Shapiro (1986)
How size effect is analyzed with event

study methodology?
How Consumption CAPM and CAPM
performs ?
US Data [1975
1982]
US Data [1959
1982]
89
Jorion and
Schwartz (1986)
How Canadian stock market integrated

with NYSE?
Canadian Data
[1963 1982]
CAPM and
lAPM
MLE
90
Litzenberger
and Ronn
(1986)
How utility based model performs?
US Data [1926
1982]
Utility
based model
OLS, MLE,
method of
moments
91
Tinic and West

(1986).
McInish and
Wood (1986)
How CAPM performs?
US Data [1935
1982]
US Data [1971
1972]
CAPM
OLS
CAPM
93
McDonald
(1987)
US Data [1961
1985]
CAPM
94
MacKINLAY
(1987)
How to deal with the abnormal returns

when systems method is used in addition
with event study?
How to distinguish CAPM from other asset
pricing model through multivariate tests?
Linear
programming
model to
estimate betas
OLS+GLS+IGL
S(iterated GLS )
US Data [1954
1983]
CAPM
Multivariate
tests
95
Corhay, et.al.,
(1987)
How seasonality differs among stock

exchanges?
US, UK and
France Data
[1969 1983]
CAPM
OLS
88
92
What is the extent of bias in beta estimates

due to thin trading and price adjustment
delays?
Model
164
CAPM
(zero beta
CAPM )
CAPM
CAPM and
CCAPM
Estimation
Techniques
MLE
OLS + Event
study
OLS + GLS
Conclusion
The index lies on the efficient set hyperbola, the Black version
of the asset-pricing model is not rejected, and the small firm
anomaly disappears.
Overall performance can appear significantly positive or
negative, depending on the choice of index and methodology.
The data examined in the paper provide no support for the
consumption CAPM as compared to the traditional
formulation.
An international CAPM was not a good description of the
pricing of Canadian securities for the period from 1968
through 1982. The joint hypothesis of integration of the North
American equity market combined with the CAPM it is
rejected. There is evidence of segmentation in the pricing of
Canadian stocks.
Over the same holdout period, the utility-based model correctly
predicts the direction of aggregate common stock price
movements 70% of the time, which compares with a 55% for
the risk-neutral model, for the Williams-Gordon-Rubinstein
model, for the simple technical model.
The results do not support the important implications of the
CAPM.
Evidence is provided that bias due to thin trading and price
adjustment delays is substantial for NYSE stocks when daily
returns are used
Although systems methods have various characteristics that are
amenable to event study applications, the promise of these
methods is not supported by a variety of empirical tests.
The tests can have reasonable power if the deviation is random
across assets. But if the deviation is the result of missing
factors (as is the case in many competing models), the tests are
quite weak.
Empirical evidence reveals a common characteristic across the
four stock exchanges: the presence of persistent seasonalities
in these markets' risk premium and stock returns

Code Reference
Research Question
96
Cho and Taylor

(1987)
Do returns and correlation coefficients,

correlation matrices and covariance
matrices, the number of return-generating
factors differ and pricing relationships
differ across calendar months and groups?
97
Collins, et.al.,
(1987)
98
165
Data-[Time
period]
US Data [1973
1983]
Model
Is there a broader and richer information

set available about the activities of larger
firms vis--vis smaller firms?
US Data [1968
1980]
CAPM
OLS (random
walk model
valuation model
+ RWM with
drift)
Shanken (1987)
How efficiency of given portfolio is tested

through Bayesian approach?
US Data [1926
1982]
MPT
Bayesian
approach test for
efficiency
99
Shanken (1987)
How CAPM performs when different

proxy for market portfolio is used?
US Data [1953
1983]
CAPM
OLS+MLE
100
French, et.al.,
(1987)
Is the expected market risk premium

positively related to risk as measured by
the volatility at the stock market?
US Data [1928
1984]
CAPM
OLS+WLS+
modified WLS
APT
Estimation
Techniques
Factor analysis
(maximum
likelihood) +
modified GLS
Conclusion
The results show that there is a January effect and a small-firm
effect in stock returns. Correlation matrices are more stable
than covariance matrices, but both types of matrices are not
stable across months and across the sample groups. The
number of return-generating factors is rather stable most of the
time and for most of the sample groups, but there is some
significant instability that is related to the average correlation
coefficients among stocks. The APT pricing relationship does
not seem to be supported by the two-stage process using the
maximum-likelihood factor analysis
Price-based earnings will outperform univariate time series
forecasts by a greater margin for larger firms than for smaller
firms. Size is viewed as a proxy for available information in
addition to that which is reflected in the past time series of
earnings and for the number of market participants gathering
and processing information.
The analysis indicates that significance levels higher than the
traditional 0.05 level are recommended for many test
situations. in an example from the literature. The classical test
fails to reject with p-value 0.082. Yet the odds are nearly two to
one against efficiency under apparently reasonable
assumptions.
Empirical evidence has been presented which suggests that
either the Sharpe-Lintner CAPM is invalid or our proxies
account for at most two-thirds (rejected at the 0.05 level), or
perhaps only one-half (rejected at the 0.10 level), of the
variation in the true market return. The results are essentially
the same whether we use the CRSP equal-weighted stock index
alone, or together with the Ibbotson-Sinquefield long-term U.S.
government bond index, in a multivariate proxy.
The expected market risk premium (the expected return on a
stock portfolio minus the Treasury bill yield) is positively
related to the predictable volatility of stock returns. There is
also evidence that unexpected stock market returns are
negatively related to the unexpected change in the volatility of
stock returns.
Code
Reference
Research Question
Data-[Time
period]
US Data [1966
1982]
Model
CAPM
166
Estimation
Techniques
OLS
Conclusion
A single risk premium model of expected returns is not rejected

if the premium is allowed to vary over time and if the risk
measures associated with that premium are not constrained to
equal market betas.
The conditional covariance matrix of the asset returns is
strongly autoregressive. The data clearly reject the assumption
that this matrix is constant over time.
101
Freeman
(1987)
Do the abnormal security returns related to

accounting earnings occur (begin and end)
earlier for large firms than for small firms
(timing hypothesis)?
102
Ferson, et.al.,
(1987)
How tests of asset pricing with time-varying

expected risk premiums and market betas
perform?
US Data [1963
1982]
CAPM
Maximum
likelihood
methods
103
Bollerslev,
et.al., (1988)
US Data [1959
1984]
CAPM
104
Kroll and Levy

(1988)
Do all investors choose mean-variance

efficient portfolios with one period horizon
although they need not have identical utility
functions?
What are the effects of the correlations
between the risky assets on investment
portfolios? Is separation theorem valid?
Experimental
(questionnaire)
data
CAPM and
MPT
(GARCH-M)
maximum
likelihood
estimation
Mean-variance
mathematics +
ANOVA
105
Burmeister and
McElroy
(1988)
US Data [1972
1982]
CAPM and
APT
Iterated
nonlinear WLS,
iterated
nonlinear SUR
and iterated
nonlinear three
stage least
squares.
106
Connor and
Korajczyk
(1988)
US Data [1964
1983]
APT and
CAPM
Asymptotic
principal
component
(factor
analysis)+OLS
The security prices of large firms anticipate accounting

earnings earlier than the security prices of small firms, and the
magnitude of abnormal returns associated with good or bad
news from a common class of signals (in the current study,
accounting earnings) is inversely related to firm size.
As predicted by the CAPM, in most cases the subjects

diversified their investment capital among the three risky assets.
However, on the average the subjects invested considerably
more than predicted in the riskiest asset. The introduction of a
riskless asset did not enhance homogeneity in investment
behavior, in contradiction to the Separation Theorem
The January effect is an important determinant of expected
returns. The existence of a January effect that is not explained
by this set of factors is evident, but, it would be trivial to add a
portfolio that exhibits a strong January effect and hence
represents a "January factor." Including or excluding a
January effect has, however, no appreciable effect on the
following results from nested testing: the CAPM restrictions on
the APT are rejected; the APT restrictions on the LFM are not
rejected.
The APT performs much better than either implementation of
the CAPM in explaining the January-specific mispricing related
to firm size. This result is due to seasonality in the estimated
risk premiums of the multi-factor model that is not captured by
the single-factor CAPM relations, even though the premium in
the latter model also exhibits seasonality
167
Code Reference
Research Question
Data-[Time period]
Model
Estimation
Techniques
OLS(modified
OLS)+ SURR
107
Chan and NaiFu Chen (1988)
How CAPM performs?
US Data [1949
1983]
CAPM
108
Jaffe, et.al.,
(1989)
What is the relation at earnings yields,

market value (size) with stock returns?
US Data [1951
1986]
CAPM
SURR+OLS
109
Korajczyk and
Viallet (1989)
How asset pricing models perform in

international settings?
US Data [1969
1983]
CAPM and
APT
110
Harlow and
Rao (1989)
How MLPM performs?
US Data [1931
1980]
MPLM
CAPM
OLS +factor
analysis
(asymptotic
principal
components
technique)
OLS+SURR
procedure
111
Bodurtha, and
Mark (1991)
How CAPM (conditional) performs?
US Data [1926
1985]
Conditional
CAPM
GMM (Garch
specification)
112
Cochrane
(1991)
How investment-based CAPM performs?
US Data [1947
1987]
Investmentbased
CAPM
OLS
113
Tan (1991)
How three moment CAPM performs?
US Data [1970
1986]
Three
moment
CAPM
OLS
Conclusion
Although our results show that the pricing equation cannot
be rejected in favor of the alternative pricing equation with
the firm-size variable, theoretical reasoning suggests that we
should have a multifactor asset-pricing model if risks
corresponding to a changing investment opportunity set.
Research finds significant E/P and size effects when
estimated across all months during the 1951-1986 period.
The findings also indicate a difference between January and
the rest of the year.
There is some evidence against all of the models, especially
in terms of pricing common stock of small-market-value
firms. Multifactor models tend to outperform single-index
CAPM-type models in both domestic and international forms.
Using market data, the MLPM model was tested against an

unspecified alternative. For the CRSP equally weighted
index, the MLPM model could not be rejected for a large set
of alternative target rates of returns.
It is found strong evidence of time variation in the
conditional first and second moments of excess stock returns.
The first- and third-order lags in the conditional variance of
the market risk premium, as well as in the conditional
covariance between the returns of five value-weighted
portfolios and the market were found to be significant. These
results suggest that monthly and quarterly variability
components are priced in equity excess returns.
Investment returns do not explain the component of stock
returns forecastable by dividend-price ratios. Dividend-price
ratios seem to forecast a long horizon component in stock
returns not present in investment returns.
The tests of the TMCAPM show that the average return over
time on the selected mutual funds tends to deviate from the
predictions of the model. They are generally flatter than
predicted by TMCAPM, implying that tradeoffs of risks for
return are less than predicted.
168
Code Reference
Research Question
Data-[Time period]
Model
114
Lilian Ng
(1991)
How conditional CAPM performs?
US Data [1926
1987]
Conditional
CAPM
Estimation
Techniques
GMM (GARCH
specification)
115
Hamori (1991)
How C-CAPM performs?
Japanese Data
[1980 1988]
C-CAPM
GMM
116
Sauer and
Murphy (1992)
How CCAPM and CAPM perform?
German Data
[1968 1988]
CCAPM
and CAPM
GLS
117
Fama and
French (1992)
What is the relation of size and book-tomarket equity with stock returns?
US Data [1962
1989]
CAPM
OLS
118
Fama and
French (1993)
What are the relevant factors that affect

stock and bond returns?
US Data [1963
1991]
CAPM and
Three factor
model
OLS
119
Handa, et.al.,
(1993)
How the return interval affects betas?
US Data [1926
1982]
CAPM
OLS+GLS
120
Zhou (1993)
How asset pricing tests perform under

alternative distributions?
US Data [1926
1986]
CAPM
MLE
Conclusion
Empirical results based on the pooled time series and crosssection of beta-ranked portfolio returns do not reject the
conditional mean-variance efficiency of the market proxy
portfolio. The findings also indicate that the ratio of expected
excess market return to the conditional market variance, or
the reward-to-risk ratio, is positively correlated with the level
of the conditional market variance. When tests are based on
ten size-sorted portfolios, however, the tests reject the model.
The estimation results of C-CAPM in Japan are totally
different from those in the United States. These results are
not robust and at least in Japan the model is consistent with
the movements of asset returns.
This research finds evidence that the CAPM is a better
indicator of capital asset pricing in Germany than the
CCAPM.
For the 1963-1990 period, size and book-to-market equity
capture the cross-sectional variation in average stock returns
associated with size, E/P, book-to-market equity, and
leverage.
The three stock-market factors are largely uncorrelated with
one another and with the two term-structure factors. The
regressions that use the proxy return for market portfolio,
SMB, HML, TERM and DEF as factors to explain stock and
bond returns thus provide a good summary of the separate
roles of the five factors in the volatility of returns and in the
cross-section of average returns.
Beta changes with the return interval because an asset
returns covariance with the market return and the market
returns variance may not change proportionately as the
return interval is varied. The evidence is consistent with the
market model betas changing predictably with the return
interval. Betas of high-risk securities increase with the
decrease with the return interval, whereas betas of low-risk
securities decrease with the return interval.
If the returns are elliptically distributed, empirical studies
that ignore the non-normality are likely to over-reject the
theory being tested, but the proposed approach can be used
to detect the magnitude of the over-rejection.
169
Code Reference
Research Question
Data-[Time period]
Model
Estimation
Techniques
GLS(3 SLS)+
(Semiautoregressive
system )+factor
analysis
factor analysis +
GLS
121
Mei (1993)
US Data [1989
1993]
CAPM,
APT
122
Chen and
Jordan (1993)
How APT performs?
US Data [1971
1986]
APT
123
Ferson and
Harvey
(1993)
How multifactor model performs?
18 national equity
markets [1970
1989]
Multifactor
model
(SUR ) GMM
124
Pettengill,
et.al., (1995)
How CAPM performs?
US Data [1926
1990]
CAPM
OLS
125
Cochrane
(1996)
How investment-based CAPM performs?
US Data [not
stated]
Investment
based
CAPM
GMM (iterated
GMM)+GLS
126
Campbell
(1996)
How the multifactor model performs?
US Data [1952
1990]
Multifactor
models
GMM (VAR
specification)
127
Jagannathan
and Wang
(1996)
How conditional CAPM performs?
US Data [1962
1990]
Conditional
CAPM
OLS+GMM
Conclusion
Historical returns can be used to approximate the
unobservable factor loadings and factors can be estimated by
running a series of semi autoregressions.
A number of tests are run in this study to compare the
performance of two empirical versions of the APT, a factor
loading model (FLM) and a macroeconomic variable model
(MVM). The viability of the MVM to the FLM is suggested by
all three sets of test results.
Although previous studies do not reject the unconditional
mean-variance efficiency of a world equity market portfolio,
we find that the world market betas provide a poor
explanation of the average returns across countries.
A systematic relation exists between beta and returns for the
total sample period and is consistent across subperiods and
across months in a year, and a positive tradeoff between
beta and average portfolio returns is observed.
The simple investment return model performs surprisingly
well. The investment return factors significantly price assets,
the model is not rejected, and it is able to explain a wide
spread in expected returns, including managed portfolio
returns formed by multiplying returns with instruments.
The implications of the intertemporal model for the
conditional moments of asset returns are strongly rejected,
although there is only weak evidence against its implications
for unconditional moments.
When betas and expected returns are allowed to vary over
time by assuming that the CAPM holds period by period, the
size effects and the statistical rejections of the model
specifications become much weaker. When a proxy for the
return on human capital is also included in measuring the
return on aggregate wealth, the pricing errors of the model
are not significant at conventional levels. More importantly,
firm size does not have any additional explanatory power.
170
Code Reference
Research Question
Data-[Time period]
Model
128
Clare, et.al.,
(1998)
How CAPM performs?
UK Data [1980
1993]
CAPM
129
Naranjo,
et.al., (1998)
Do stocks with higher anticipated dividend

yields earn higher risk-adjusted returns?
US Data [1963
1994]
TFM
Estimation
Techniques
NLSUR (Nonlinear Seemingly
Unrelated
Regression)
OLS, SUR
130
Chan, et.al.,
(1998)
How common factor affect stock returns?
US and Japanese
Data [1968
1994]
Factor
Models
OLS, Factor
Analysis
131
Rouwenhorst
(1999)
Are similar return factors present around the

world?
20 Emerging
Markets Data
[1975 1997]
TFM
OLS
132
Lettau and
Ludvigson
(2001)
How CAPM and CCAPM perform?
US Data-- [1963
1998]
OLS, GMM
133
Dittmar
(2002)
How four moment CAPM performs?
US Data [1963
1995]
CAPM,
CCAPM,
TFM
Conditional
CAPM
FMCAPM,
TFM
134
Wang (2003)
How CAPM, conditional CAPM and three

factor model performs?
US Data [1947
1995]
CAPM
conditional
CAPM ,
TFM
135
Vorkink
(2003)
How different estimations techniques affect

tests results?
US Data [1963
1995]
CAPM
OLS+GMM+HLV
136
Acharya and
Pedersen
(2005)
How Liquidity Based CAPM performs?
US Data [1962
1999]
Liquidity
Based
CAPM
GMM
Hansen
Jagannathan
estimator (modified
GMM)
OLS+WLS+GMM+
BHV
(Bansal,hsiesh,Visw
onathan)
Conclusion
A significant and powerful role for beta in explaining
expected returns is found.
Returns are positively related to that yield. This holds true

even after making risk adjustments based on the FamaFrench factors and macroeconomic risk factors from the
asset pricing literature.
The performance of these Macroeconomic factors to be quite
disappointing. With the exception of the factors related to the
default premium and the term premium, the macroeconomic
factors do a poor job in explaining return co-variation.
The return factors in emerging markets are qualitatively
similar to those in developed markets: Small stocks
outperform large stocks, value stocks outperform growth
stocks and emerging markets stocks exhibit momentum.
Scaled consumption CAPM does a good job of explaining the
celebrated value premium: portfolios with high book-tomarket equity ratios also have returns that are more highly
correlated with the scaled consumption factors we consider,
and vice versa.
The pricing kernels implied by both a linear single- and a
linear multi-factor model appear unable to explain the crosssectional variation in port folio returns.
The momentum effect does not seem to be a serious anomaly
to the nonparametric conditional version of the Fama and
French model. According to the model, the winners tend to
have conditional expected returns that are significantly
higher than the losers.
Contrary to the OLS and GMM estimators, the Hodgson,
Linton, and Vorkink (2002) estimator fails to reject the linear
CAPM on the group of size-sorted portfolios. We find that the
OLS-GMM rejection of the CAPM is driven by sensitivity to
outliers in the size-sorted data.
The liquidity-adjusted CAPM explains the data better than
the standard CAPM, while still exploiting the same degrees
of freedom.
Note: CAPM is referring to Sharpe Lintner CAPM; TFM is referring to Three Factor Model of Fama and French; FMCAPM is referring to Four Moment CAPM;
171
7. Concluding Remarks
The purpose of this paper is to give a comprehensive theoretical review devoted to asset pricing
models by emphasizing static and dynamic versions in the line with their empirical investigations.
This paper fills the gap in literature by giving a comprehensive review of the models and evaluating
the historical stream of empirical investigations in the form of structural empirical review. The
distinctiveness of the study is that this is the first attempt to review literature written on asset pricing
models and the empirical investigation conducted in the form of structural empirical review. In doing
so, the historical perspective of the concept and the place it will take in future are clarified and the way
further researches conducted will be explored. As it is highlighted in section 6, we present 136
research question investigated in asset pricing literature. Concluding remarks can be divided into two
main categories such as theoretical perspective and empirical investigation perspective. In terms of
theoretical perspective, we show that asset pricing models try to adopt additional variables into pricing
process. This procedure is starting with the relaxing one of the assumptions of the previous model or
approaching the problem from different perspectives. From static, one period model we see that
dynamic, intertemporal models get the higher attention than static, one period models. In terms of
empirical investigation perspective, it is documented that econometric advancement takes its biggest
place ever in financial literature when compared with the other field. Almost every single econometric
estimation technique is used to determine the most unbiased estimators of given model. This
underlines the fact that the direction of advancing a methodology is changing from financial literature
to economics due to the fact that there is huge account of raw data available to analyze. Future
research direction should be judging the empirical power of the asset pricing models and their role in
practice for incorporating a new dimension to the model.
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International Journal of Economics and Financial Issues

Vol. 2, No. 2, 2012, pp.141-178

Theoretical and Empirical Review of Asset Pricing Models:

Theoretical and Empirical Review of Asset Pricing Models: A Structural Synthesis

Preferences over uncertain wealth distributions

Appropriate statistical judgments

Heuristics and biases

Behavioral asset pricing

Markowitz Mean-Variance Algorithm

Sharpe (1964), Lintner (1965), Mossin (1966)

Black Zero-beta CAPM

The CAPM with Non-Marketable Human Capital Mayers (1972)

Solnik (1974a), Adler and Dumas (1983)

Arbitrage Pricing Theory

The Fame-French Three Factor Model

Fama and French (1993)

The Three Moment CAPM

Rubinstein (1973), Kraus and Litzenberger (1976)

The Four Moment CAPM

Fang and Lai (1997), Dittmar (1999)

The Intertemporal CAPM

The Consumption CAPM

Production Based CAPM

Lucas (1978), Brock (1979)

Liquidity Based CAPM

Acharya and Pedersen (2005)

Jagannathan and Wang (1996)

This is Dittmar working paper whereas article form is published in 2002.

Theoretical and Empirical Review of Asset Pricing Models: A Structural Synthesis

Sorted by impact factor (2006)

Serach for 'CAPM

Serach for 'CAPM

Theoretical and Empirical Review of Asset Pricing Models: A Structural Synthesis

4. Theoretical Framework of Static Asset Pricing Models

premium ( X E RM r f ). ( E R M is the expected return of hypothetical market portfolio return

P COVRXi , RMi PH COVRXi , RMi

PH : total value of all nonmarketable assets

The CAPM with Multiple Consumption Goods

VARRP COV RX , RM COV RM , RP COV RX , RP

VARRP COV RX , RP COV RM , RP COV RX , RM

RWM denotes the return on the worldwide market portfolio.

Theoretical and Empirical Review of Asset Pricing Models: A Structural Synthesis

, the APT predicts:

X 1,2,...., n ............................................................... (6.2)

The Fame-French Three Factor Model

E R X r f X 1 E RM r f X 2 E SMB X 3 E HML ...........................(7)

The Three Moments CAPM

R Xi r f c0i c1i RMi r f c 2i RM R M

market model by ( R M R M ) 2 , taking expected values and dividing through by ( R M R M ) 3 , yields en

The forth central moment of the rate of return on market portfolio

The Four Moments CAPM

E R X r f 1COV R M , R X 2 COV RM2 , R X 3COV R M3 , R .................(10)

See equation 6 in Kraus and Litzenberger (1976).

Theoretical and Empirical Review of Asset Pricing Models: A Structural Synthesis

5. Theoretical Framework of Dynamics Asset Pricing Models

E R X r f 1 X E R M r f 2 X E R NF r .......... .......... .......... .......... ......(11)

E R X r f X ,C E RC r f .......... .......... .......... .......... .......... .......... .......... ...(12)

ERC is return obtained by creating a mimicking portfolio with stochastic return

E RtX1 rt f Xy ( E Rty1 rt f ) .................................................(13)