The CAPM with Endogenous Beliefs

32 Pages Posted: 6 Mar 2008

See all articles by Hendri Adriaens

Hendri Adriaens

CentERdata, Tilburg University

Bas Donkers

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Erasmus Research Institute of Management (ERIM); Tinbergen Institute

Bertrand Melenberg

Tilburg University - Center for Economic Research (CentER)

Date Written: March 2008

Abstract

The CAPM is one of the basic models in finance, combining one-period ahead exogenously given (rational) expectations and mean-variance preferences. This combination results in implications that are heavily criticized, both empirically and theoretically, resulting in a rejection of mean-variance preferences. In this paper we consider the CAPM as an equilibrium model of interacting mean-variance investors where the investors' beliefs are not assumed to be given exogenously, but are determined endogenously, as part of the CAPM equilibrium. We postulate that according to these beliefs arbitrage opportunities are excluded and that these beliefs are rational, i.e., in line with the CAPM equilibrium, so that the standard way of testing the CAPM no longer applies. Instead, we derive clear one-period ahead predictions. When confronting such predictions with actual data, the one-factor CAPM performs quite well, much better than the traditional, alternative multi-factor models, when the comparable predictions according to these models are confronted with actual data.

Keywords: Asset pricing, CAPM, endogenous beliefs

JEL Classification: G12

Suggested Citation

Adriaens, Hendri and Donkers, Bas and Melenberg, Bertrand, The CAPM with Endogenous Beliefs (March 2008). AFA 2009 San Francisco Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1102263 or http://dx.doi.org/10.2139/ssrn.1102263

Hendri Adriaens

CentERdata, Tilburg University ( email )

NL-5000 LE Tilburg
Netherlands

Bas Donkers

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
Rotterdam, NL 3000 DR
Netherlands
+31 10 408 2411 (Phone)
+31 10 408 9169 (Fax)

HOME PAGE: http://https://www.eur.nl/en/people/bas-donkers

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 2411 (Phone)
+31 10 408 9169 (Fax)

HOME PAGE: http://https://www.eur.nl/en/people/bas-donkers

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Bertrand Melenberg (Contact Author)

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2730 (Phone)

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