A Business Cycle Capital Asset Pricing Model

72 Pages Posted: 25 Jan 2021 Last revised: 22 Mar 2021

See all articles by Wai Man Tse

Wai Man Tse

Chu Hai College of Higher Education

Date Written: December 23, 2020

Abstract

We introduce a market, liquidity, credit, and business-cycle risks asset pricing model. Because of the phase-switching business-cycle risks and price-setting monopolistic competition, it has rational expectations and predictability. The unconditional-predicted and observed return volatilities are equal. However, their conditional returns are different. They mitigate the excessive volatility and equity premium puzzle. The risk-return tradeoff dynamic disequilibrium model builds on the equilibrium CAPM, taken as its steady state. Using the last 30-year S&P 500 data, reversal, and momentum investment strategies, it has competitive in-sample explanatory and superior out-of-sample predictive power, above the CAPM, Fama-French three-factor model, and its variants.

Keywords: Business-Cycle CAPM, Rational Expectations, Predictability, Real Interest Rates, Idiosyncratic Volatility, Equity Premium Puzzles, Monopolistic Competition

JEL Classification: G11, G12

Suggested Citation

Tse, Wai Man, A Business Cycle Capital Asset Pricing Model (December 23, 2020). Available at SSRN: https://ssrn.com/abstract=3754068 or http://dx.doi.org/10.2139/ssrn.3754068

Wai Man Tse (Contact Author)

Chu Hai College of Higher Education ( email )

80 Castle Peak Road, Castle Peak Bay, Tuen Mun
New Territories
Hong Kong
(852) 9262 5516 (Phone)

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