Working Paper: NBER ID: w9974
Authors: Jonathan Lewellen; Stefan Nagel
Abstract: Recent studies suggest that the conditional CAPM might hold, period-by-period, and that time-varying betas can explain the failures of the simple, unconditional CAPM. We argue, however, that significant departures from the unconditional CAPM would require implausibly large time-variation in betas and expected returns. Thus, the conditional CAPM is unlikely to explain asset-pricing anomalies like book-to-market and momentum. We test this conjecture empirically by directly estimating conditional alphas and betas from short-window regressions (avoiding the need to specify conditioning information). The tests show, consistent with our analytical results, that the conditional CAPM performs nearly as poorly as the unconditional CAPM.
Keywords: No keywords provided
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| significant deviations from the unconditional CAPM (G19) | implausibly large time variation in betas and expected returns (C46) |
| conditional CAPM holds (G12) | unconditional alpha should be approximately equal to the covariance between the asset's beta and the market risk premium (G17) |
| average conditional alphas are around 0.50 for the long-short book-to-market strategy (G12) | average conditional alphas are statistically significant and close to the unconditional alphas of 0.59 (C46) |
| average conditional alphas are around 1.00 for the long-short momentum strategy (C10) | average conditional alphas are statistically significant and close to the unconditional alphas of 1.01 (C46) |
| time-varying betas (C22) | observed pricing errors are too large to be explained (D40) |
| covariances of betas with market conditions (C46) | explore the relationship between time-varying betas and observed pricing errors (C22) |