Misspecification of CAPM : Implication for size and book-to-market effect
Document Type
Other
Publisher
Edith Cowan University
Place of Publication
Joondalup, Western Australia
Faculty
Faculty of Business and Public Management
School
School of Finance and Business Economics
Abstract
In light of the inadequacy of Sharpe’s one-period Capital Asset Pricing Model (CAPM) in explaining stock returns, this paper develops a multi-period CAPM that captures more variation in average stock returns. Specifically, the derivation of the generalized model captures growth in earnings as an additional factor besides beta. This suggests that Sharpe’s CAPM may be misspecified due to the omission of the earnings growth variable. In addition, it may explain why size and book-to-market effect found by Fama and French are significant when they are regressed along with beta since earnings growth and the two anomalies are highly correlated.
Comments
Lin, C., & Sears, R.S. (2001). Misspecification of CAPM : Implication for size and book-to-market effect. Joondalup, Australia: Edith Cowan University.