Working Paper: NBER ID: w29016
Authors: Jianan Liu; Tobias J. Moskowitz; Robert F. Stambaugh
Abstract: We investigate whether various asset pricing models could hold in an efficient market. Assuming decade-old information should be priced correctly, we test whether a model assigns zero alpha to investment strategies that use only such information. The CAPM passes this test, but prominent multifactor models do not. Multifactor betas may help capture expected returns on mispriced stocks, but persistence in those betas distorts the stocks' implied expected returns after prices correct. Such effects are strongest in large-cap stocks, whose multifactor betas are the most persistent. Hence, prominent multifactor models distort expected returns, absent mispricing, for the largest, most liquid stocks.
Keywords: Asset Pricing; Market Efficiency; CAPM; Multifactor Models
JEL Codes: G12; G14; G40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CAPM (O22) | expected returns (G17) |
| multifactor models (C38) | expected returns (G17) |
| observable characteristics (C90) | expected returns (G17) |
| profitability and distress characteristics (G33) | investor underreaction (G41) |
| investor underreaction (G41) | predictive ability of models (C52) |
| time (C41) | correction of mispricing (G19) |