Resource Allocation in the Brain and the Capital Asset Pricing Model

Abstract

Using recent findings from brain sciences, we model the human brain as solving two optimization problems instead of one, which are (i) optimal resource allocation in the brain and (ii) mean-variance optimization. We show that this changes the CAPM in only one way: an alpha appears which potentially contributes to momentum, value, high-alpha-of-low-beta, and size effects. Resource allocation in the brain suggests that the momentum effect is most robust, followed by value, with size effect being the least robust. SML slope varies with resource allocation decisions in the brain suggesting a new approach to the overnight effect and related puzzles..

Keywords: CAPM, Value Effect, Size Effect, Momentum Effect, Betting-Against-Beta, Schema, Neuroscience

JEL Classification: G12, G10