Asset Pricing Model Estimation Errors During Rational and Irrational Investor Behavior Periods

Abstract

This paper examines the prediction that human behavior changes the outcome of market predictability, indicated by a difference in asset pricing model estimated prediction error, calculated using the Sharpe ratio, Jensen’s alpha, and the Treynor measure for publicly traded firms in the consumer discretionary and consumer staples sectors. Applying a series of independent t-tests to mean comparisons of these measures ultimately provided mixed results, demonstrating a statistically significant difference only with Jensen’s alpha and the Sharpe ratio in both sectors. This indicates a need for extra caution for asset pricing model use under potentially irrational periods.

Keywords: Asset Pricing, Behavioral Finance, Irrationality, Beta

JEL Classification: G12, G41