The CAPM Strikes Back? An Investment Model with Disasters

Hang Bai, Kewei Hou, Howard Kung and Lu Zhang ()

No 21016, NBER Working Papers from National Bureau of Economic Research, Inc

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: E32 E44 G12 G14 (search for similar items in EconPapers)
Date: 2015-03
New Economics Papers: this item is included in nep-mac
Note: AP CF EFG
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