Π-CAPM: The Classical CAPM with Probability Weighting and Skewed Assets

69 Pages Posted: 28 Nov 2020 Last revised: 6 Dec 2021

See all articles by Joost Driessen

Joost Driessen

Tilburg University - Tilburg University School of Economics and Management; Tilburg University - Center for Economic Research (CentER)

Sebastian Ebert

Frankfurt School of Finance & Management; Frankfurt School of Finance & Management

Joren Koëter

Rotterdam School of Management, Erasmus University

Date Written: December 3, 2021

Abstract

We propose a new asset pricing model which generalizes the mean-variance framework by including probability weighting, specifically the overweighting of rare, high-impact events. Our model—the Π-CAPM—allows for disentangling the price impact of volatility and skewness. We show that the price impact of volatility is skewness-dependent, negative for left-skewed assets but potentially positive for right-skewed assets. Further, probability weighting translates into an exaggerated co-movement of assets and can explain the empirical correlation premium. Finally, we empirically verify that option-implied variance premiums for individual stocks depend on the stock’s skewness, in the way predicted by the Π-CAPM.

Keywords: asset pricing, behavioral finance, probability weighting, option markets

JEL Classification: G02, G11, G12

Suggested Citation

Driessen, Joost and Ebert, Sebastian and Ebert, Sebastian and Koëter, Joren, Π-CAPM: The Classical CAPM with Probability Weighting and Skewed Assets (December 3, 2021). Available at SSRN: https://ssrn.com/abstract=3711478 or http://dx.doi.org/10.2139/ssrn.3711478

Joost Driessen

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Sebastian Ebert

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt, 60322
Germany

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt, 60322
Germany

Joren Koëter (Contact Author)

Rotterdam School of Management, Erasmus University ( email )

RSM Erasmus University
PO Box 1738
Rotterdam, 3062 PA
Netherlands

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