Resource Allocation in the Brain and the Capital Asset Pricing Model

Abstract

Using recent findings from brain sciences, we model the human brain as optimizing on its own internal resources before optimizing on the resources available in the external world. We show that this changes the CAPM in only one way: an alpha appears that generates effects similar to momentum, value, high-alpha-of-low-beta, and size. Resource allocation considerations in the brain suggest that momentum effect is the most robust, followed by value, with size effect being the least robust. Slope of the security-market-line (SML) varies with resource allocation decisions in the brain suggesting a new approach to the overnight effect and related puzzles.

Keywords: Resource Allocation in the Brain, CAPM, SML Slope, Overnight Effect, Value Effect, Size Effect, High-Alpha-Low-Beta, Momentum Effect

JEL Classification: G12, G10