W-MPS Risk Aversion and the Shadow CAPM: Theory and Empirical Evidence

48 Pages Posted: 21 Sep 2016

See all articles by Lin Huang

Lin Huang

Southwestern University of Finance and Economics (SWUFE) - Research Institute of Economics & Management

Chenghu Ma

Fudan University - School of Management

Hiroyuki Nakata

University of Tokyo - Faculty of Economics

Date Written: August 1, 2015

Abstract

This paper presents the shadow Capital Asset Pricing Model (CAPM) of Ma (2011a) as an intertemporal equilibrium asset pricing model, and tests it empirically. In contrast to the classical CAPM - a single factor model based on a strong behavioral or distributional assumption, the shadow CAPM can be represented as a two factor model, and only requires a modest behavioral assumption of weak form mean-preserving spread (w-MPS) risk aversion. The empirical tests provide support in favor of the shadow CAPM over the classical CAPM, the Consumption CAPM, or the Epstein and Zin (1991) model. Moreover, the shadow CAPM provides a consistent explanation for the cross-sectional variations of expected returns on the stocks and for the time-varying equity premium.

Keywords: equity premium, w-MPS risk aversion, recursive utility, shadow price

JEL Classification: G12, G11

Suggested Citation

Huang, Lin and Ma, Chenghu and Nakata, Hiroyuki, W-MPS Risk Aversion and the Shadow CAPM: Theory and Empirical Evidence (August 1, 2015). Available at SSRN: https://ssrn.com/abstract=2841120 or http://dx.doi.org/10.2139/ssrn.2841120

Lin Huang (Contact Author)

Southwestern University of Finance and Economics (SWUFE) - Research Institute of Economics & Management ( email )

55 Guanghuacun Street
Chengdu, Sichuan 610074
China

Chenghu Ma

Fudan University - School of Management ( email )

No. 670, Guoshun Road
Shanghai, 200433
China

Hiroyuki Nakata

University of Tokyo - Faculty of Economics ( email )

7-3-1 Hongo, Bunkyo-ku
Tokyo 113-0033
Japan

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