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Can CRRA preferences explain CAPM-anomalies in the cross-section of stock returns?


Elmiger, Sabine (2013). Can CRRA preferences explain CAPM-anomalies in the cross-section of stock returns? Swiss Finance Institute Research Paper 13-43, University of Zurich.

Abstract

A large number of empirical studies find evidence for systematic deviations from the CAPM. The CAPM tends to understate the returns on low-beta stocks and overstate the returns on high-beta stocks, which means that the security market line is too steep. Other well-documented anomalies are the size premium and the value premium. The CAPM is a special case of the consumption-based CAPM. This study addresses the question whether the consumption-based CAPM with constant relative risk aversion preferences can explain CAPM-anomalies. An example of an economy with power utility and lognormal returns is examined that can be solved in closed form. The model leads to a security market line that is flatter than in the CAPM and generates a size and a value premium. The comparative statics suggest that cross-sectional anomalies and the equity premium puzzle are of a very similar nature.

Abstract

A large number of empirical studies find evidence for systematic deviations from the CAPM. The CAPM tends to understate the returns on low-beta stocks and overstate the returns on high-beta stocks, which means that the security market line is too steep. Other well-documented anomalies are the size premium and the value premium. The CAPM is a special case of the consumption-based CAPM. This study addresses the question whether the consumption-based CAPM with constant relative risk aversion preferences can explain CAPM-anomalies. An example of an economy with power utility and lognormal returns is examined that can be solved in closed form. The model leads to a security market line that is flatter than in the CAPM and generates a size and a value premium. The comparative statics suggest that cross-sectional anomalies and the equity premium puzzle are of a very similar nature.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:19 August 2013
Deposited On:03 Mar 2014 08:23
Last Modified:08 Dec 2017 04:38
Series Name:Swiss Finance Institute Research Paper
Official URL:http://ssrn.com/abstract=2312273
Other Identification Number:merlin-id:9172

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