The performance of cross-sectional regression tests of the CAPM with non-zero pricing errors

Irina Murtazashvili and Nadia Vozlyublennaia

Journal of Banking & Finance, 2012, vol. 36, issue 4, 1057-1066

Abstract: We show that in the presence of non-zero pricing errors, the Fama–MacBeth (FM) cross-sectional regression test is very likely to either reject the Capital Asset Pricing Model (CAPM) when it (almost) holds or accept the model when it grossly fails. We investigate the case when pricing errors are correlated with betas and demonstrate that the test performance depends crucially on the correlation, cross-sectional distribution of betas, and several other parameter values. Even when the CAPM holds exactly (pricing errors are zero) the FM test is equally likely to either reject or accept the model when typical sample sizes are used.

Keywords: CAPM; Fama–MacBeth procedure; Pricing errors (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:36:y:2012:i:4:p:1057-1066

DOI: 10.1016/j.jbankfin.2011.10.018

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