Does the CAPM Predict Returns?
52 Pages Posted: 22 Apr 2019 Last revised: 26 Dec 2019
Date Written: December 18, 2019
We provide strong empirical evidence that asset excess returns can be predicted using the CAPM. When predicting next month's excess returns, the CAPM yields an out-of-sample R2 of about 4% across all portfolios and of about 2.7% across all S&P 500 stocks. That is, the predictive power of the market return predictor transmits to the product of the asset's beta and the risk premium of the market. As a consequence, strategies exploiting the predictive power of the CAPM have Sharpe ratios up to 100% larger than those of the corresponding buy-and-hold strategies.
Keywords: capital asset pricing model, predictability, cross-section of stock returns
JEL Classification: D53, G11, G12
Suggested Citation: Suggested Citation