The CAPM strikes back? An equilibrium model with disasters

Hang Bai, Kewei Hou, Howard Kung, Erica X.N. Li and Lu Zhang ()

Journal of Financial Economics, 2019, vol. 131, issue 2, 269-298

Abstract: Embedding disasters into a general equilibrium model with heterogeneous firms induces strong nonlinearity in the pricing kernel, helping explain the empirical failure of the (consumption) CAPM. Our single-factor model reproduces the failure of the CAPM in explaining the value premium in finite samples without disasters and its relative success in samples with disasters. Due to beta measurement errors, the estimated beta-return relation is flat, consistent with the beta “anomaly,” even though the true beta-return relation is strongly positive. Finally, the consumption CAPM fails in simulations, even though a nonlinear model with the true pricing kernel holds exactly by construction.

Keywords: CAPM; Rare disasters; Measurement errors; Consumption CAPM; General equilibrium (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (24)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:131:y:2019:i:2:p:269-298

DOI: 10.1016/j.jfineco.2018.08.009

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