w-MPS risk aversion and the shadow CAPM: theory and empirical evidence

Lin Huang, Chenghu Ma and Hiroyuki Nakata

The European Journal of Finance, 2017, vol. 23, issue 11, 947-973

Abstract: This paper presents the shadow capital asset pricing model (CAPM) of Ma [2011a. Advanced Asset Pricing Theory. London: Imperial College Press] as an intertemporal equilibrium asset pricing model, and tests it empirically. In contrast to the classical CAPM – a single-factor model based on a strong behavioral or distributional assumption – the shadow CAPM can be represented as a two-factor model, and only requires a modest behavioral assumption of weak form mean-preserving spread risk aversion. The empirical tests provide support in favor of the shadow CAPM over the classical CAPM, the consumption CAPM, or the Epstein and Zin [1991. “Substitution, Risk Aversion and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis”. Journal of Political Economy 99, 263–286] model. Moreover, the shadow CAPM provides a consistent explanation for the cross-sectional variations of expected returns on the stocks and for the time-varying equity premium.

Date: 2017
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DOI: 10.1080/1351847X.2015.1082495

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