Resource Allocation in the Brain and the Capital Asset Pricing Model
22 Pages Posted: 15 Jun 2020 Last revised: 6 Feb 2024
Date Written: July 13, 2020
Abstract
Leveraging recent neuroscience findings about information processing in the brain, we show that recognizing that the brain is resource-constrained gives rise to an alpha in an otherwise standard CAPM. This alpha, which converges to zero if the brain’s resource-constraint does not bind, can generate size, betting-against-beta (BAB), value, and momentum effects as well as the observed variation in the slope of the security-market-line (SML) at specific times and horizons. Our results suggest that internal resource allocation decisions in a trader’s brain is a critical neglected dimension contributing to these phenomena, with novel predictions arising about their relative strengths and robustness.
Keywords: Asset Pricing, Predictive Processing, CAPM, Security Market Line (SML) Slope, Size Effect, Betting-Against-Beta, Value Effect, Momentum Effect
JEL Classification: G41, G12
Suggested Citation: Suggested Citation