Explaining the Failure of the Unconditional CAPM with the Conditional CAPM

Management Science, forthcoming

66 Pages Posted: 2 Apr 2019 Last revised: 29 Nov 2021

See all articles by Michael Hasler

Michael Hasler

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance

Charles Martineau

University of Toronto - Rotman School of Management and UTSC Management

Date Written: August 16, 2021

Abstract

When the cost of hedging is nil, the conditional CAPM holds (Merton, 1973). We empirically test the conditional CAPM by regressing asset returns onto the product of their conditional betas and market returns. Estimated intercepts are not statistically different from zero, implying that the conditional CAPM successfully explains the conditional level of asset returns. Yet, unconditional betas do not explain the cross-section of average asset returns; the unconditional CAPM fails. We show why and how the success of the conditional CAPM actually explains the failure of the unconditional CAPM, thereby rationalizing the coexistence of these two intriguing results.

Keywords: Capital asset pricing model, cross-section of stock returns

JEL Classification: D53, G11, G12

Suggested Citation

Hasler, Michael and Martineau, Charles, Explaining the Failure of the Unconditional CAPM with the Conditional CAPM (August 16, 2021). Management Science, forthcoming, Available at SSRN: https://ssrn.com/abstract=3353903 or http://dx.doi.org/10.2139/ssrn.3353903

Michael Hasler

University of Texas at Dallas, Naveen Jindal School of Management, Department of Finance ( email )

800 West Campbell
Richarson, TX 75080
United States

Charles Martineau (Contact Author)

University of Toronto - Rotman School of Management and UTSC Management ( email )

105 St-George
Toronto, Ontario M5S3E6
Canada

HOME PAGE: http://charlesmartineau.com

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