Linear Beta Pricing with Inefficient Benchmarks in a Given Factor Structure

48 Pages Posted: 14 Jun 2019

See all articles by George Diacogiannis

George Diacogiannis

University of Piraeus

Christos Ioannidis

Aston University - Aston Business School

Date Written: May 31, 2019

Abstract

We show the equivalence between the zero-beta version of a multi-factor arbitrage pricing model and a linear pricing model utilizing undiversified inefficient benchmarks in a given factor structure. The resulting linear model is a two-beta model, with one beta related to the inefficient benchmark and another adjusting for its inefficiency. This linear model shows that there are only two distinctive and computable sources of risk, affecting security expected returns, despite the existence of several risk factors. In a short empirical example we demonstrate that the model can be employed to provide guidance and allow researchers to test for the validity of their selection of the underlying risk factors driving variations in security returns.

Keywords: Asset Pricing, CAPM, APT , factors

JEL Classification: G11, G12

Suggested Citation

Diacogiannis, George and Ioannidis, Christos, Linear Beta Pricing with Inefficient Benchmarks in a Given Factor Structure (May 31, 2019). Available at SSRN: https://ssrn.com/abstract=3397020 or http://dx.doi.org/10.2139/ssrn.3397020

George Diacogiannis

University of Piraeus ( email )

Karaoli and Dimitriou 80
80 KARAOLI & DIMITRIOU STREET
Piraeus, Attiki 18534
Greece

Christos Ioannidis (Contact Author)

Aston University - Aston Business School ( email )

Aston Triangle
Birmingham, B47ET
United Kingdom

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