The Time Series of CAPM-Implied Returns
43 Pages Posted: 2 Apr 2019 Last revised: 16 Apr 2020
Date Written: April 15, 2020
If investors can hedge risk at no cost, then the CAPM should hold period by period (Merton, 1973). That is, the time-t expected return of an asset should be equal to the product of its time-t beta and the time-t market expected return. We empirically test this CAPM relation on equity portfolios. We show that regressing portfolio excess returns onto the product of their dynamic betas and market excess returns yields intercepts that are economically small and statistically not different from zero. This provides evidence that the CAPM is highly relevant in explaining the conditional level of asset returns in the time series.
Keywords: Capital asset pricing model, cross-section of stock returns
JEL Classification: D53, G11, G12
Suggested Citation: Suggested Citation