Observable Implications of the Conditional CAPM

Abstract

Tests of the conditional CAPM are often based on the joint (internally inconsistent) hypothesis that the stock portfolio used in the tests is the theoretical, mean-variance efficient, market portfolio. I derive a new test based exclusively on the theory in the conditional CAPM. According to this test, the conditional CAPM explains asset pricing anomalies, such as the unconditional alphas and betas of momentum, value, and size portfolios. In contrast, the unconditional CAPM theory is rejected by portfolios with negative unconditional betas and positive unconditional alphas, under the same assumptions. Hence, relaxing this joint assumption does not render the CAPM untestable.

Keywords: Conditional CAPM, anomalies, test, proxy, mean-variance frontier

JEL Classification: G11, G12, G14