Working Paper: CEPR ID: DP12607
Authors: Julien Cujean; Daniel Andrei; Mungo Wilson
Abstract: A flat Securities Market Line is not evidence against the CAPM. Under the Roll (1977) critique, the CAPM is a "lost city of Atlantis," empirically invisible. In a noisy rational-expectations economy, there exists an information gap between the average investor who holds the market and the empiricist who does not observe the market portfolio. The CAPM holds for the investor, but appears flat to the empiricist. This distortion is empirically substantial and explains, for instance, why "Betting Against Beta" works; BAB really bets on true beta. Macroeconomic announcementsreduce the distortion---for a fleeting moment the empiricist catches a glimpse of the CAPM.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CAPM holds true for investors with complete information about the market portfolio (G11) | Econometrician's perception is distorted due to inability to observe this portfolio (G40) |
| Econometrician's inability to observe market portfolio (G19) | Misperception of risk and return relationships (G41) |
| Information asymmetry (D82) | Flat SML as perceived by the econometrician (C51) |
| Distortion in perception (H31) | Significant mispricing for low-beta and high-beta assets (G12) |
| Macroeconomic announcements (E60) | Temporary reduction of distortion in perception (H31) |
| Perceived mispricing (alpha) (G19) | Linked to true beta of assets (G12) |
| Informational distance between average investor and econometrician (G40) | Econometrician's beta estimates inflated or deflated (C51) |
| Econometrician's beta estimates inflated or deflated (C51) | Systematic mispricing in the market (G19) |