The CAPM Strikes Back? An Investment Model with Disasters

Hang Bai, Kewei Hou, Howard Kung and Lu Zhang (zhanglu@fisher.osu.edu)
Additional contact information
Hang Bai: OH State University
Kewei Hou: OH State University
Howard Kung: London Business School

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Value stocks are more exposed to disaster risk than growth stocks. Embedding disasters into an investment-based asset pricing model induces strong nonlinearity in the pricing kernel. Our single-factor model reproduces the failure of the CAPM in explaining the value premium in finite samples in which disasters are not materialized, and its relative success in samples in which disasters are materialized. The relation between pre-ranking market betas and average returns is flat in simulations, despite a strong positive relation between true market betas and expected returns. Evidence in the long U.S. sample from 1926 to 2014 lends support to the model's key predictions.

JEL-codes: G12 (search for similar items in EconPapers)
Date: 2015-03
New Economics Papers: this item is included in nep-fmk and nep-ger
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Citations: View citations in EconPapers (6)

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Working Paper: The CAPM Strikes Back? An Investment Model with Disasters (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2015-03

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