Behavioral Heterogeneity in the CAPM with Evolutionary Dynamics

Abstract

The paper shows how the standard two-period CAPM with exogenous wealth and exogenous returns can be extended inter-temporally by including the evolution of wealth from the Evolutionary Finance model of Evstigneev, Hens and Schenk-Hoppe (2011). The missing link between the two models is the CAPM with heterogeneous behavior derived by Hens and Naebi (2020). The paper delivers theoretical and empirical results for behavioral heterogeneity in the CAPM with evolutionary dynamics. The market selection process results in a beta based on fundamentals to which the standard beta tends to converge asymptotically. The results of our model are confirmed by data from the DJIA.

Keywords: CAPM, Heterogeneous Behavior, Evolutionary Dynamics, Fundamental Beta

JEL Classification: D53, G1, G4