A Concave Security Market Line

Enrico De Giorgi (), Thierry Post () and Atakan Yalcin ()
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Thierry Post: Koc University, Graduate School of Business
Atakan Yalcin: Koc University, Graduate School of Business

Koç University-TUSIAD Economic Research Forum Working Papers from Koc University-TUSIAD Economic Research Forum

Abstract: We provide theoretical and empirical arguments in favor of a concave shape for the security market line, or a diminishing marginal premium for market risk. In capital market equilibrium with binding portfolio restrictions, different investors generally hold different sets of risky securities. Despite the differences in composition, the optimal portfolios generally share a joint exposure to systematic risk. Equilibrium in this case can be approximated by a concave relation between expected return and market beta rather than the traditional linear relation. An empirical analysis of U.S. stock market data confirms the existence of a significant and robust, concave cross-sectional relation between average return and estimated past market beta. We estimate that the market-risk premium is at least five to six percent per annum for the average stock, substantially higher than conventional estimates.

Keywords: capital market equilibrium; asset pricing; investment restrictions; portfolio theory. (search for similar items in EconPapers)
JEL-codes: C21 G12 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2012-05
New Economics Papers: this item is included in nep-cfn and nep-fmk
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