July 1997

Solving an Empirical Puzzle in the Capital Asset Pricing Model

John Leusner, Jalal D. Akhavein, and P.A.V.B. Swamy

Abstract:

A long standing puzzle in the Capital Asset Pricing Model (CAPM) has been the inability of empirical work to validate it. Roll (1977) was the first to point out this problem, and recently, Fama and French (1992, 1993) bolstered Roll’s original critique with additional empirical results. Does this mean the CAPM is dead? This paper presents a new empirical approach to estimating the CAPM, taking into account the differences between observable and expected returns for risky assets and for the market portfolio of all traded assets, as well as inherent nonlinearities and the effects of excluded variables. Using this approach, we provide evidence that the CAPM is alive and well.

Keywords: Asset pricing, measurement errors, excluded variables

PDF: Full Paper

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Last Update: February 19, 2021