Solving an Empirical Puzzle in the Capital Asset Pricing Model

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

OCC Working Paper 97-10, June 1997

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. This approach takes 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.

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As with all OCC Working Papers, the opinions expressed in this paper are those of the author alone, and do not necessarily reflect the views of the Office of the Comptroller of the Currency or the Department of the Treasury.

Any whole or partial reproduction of material in this paper should include the following citation: Leusner, Akhavein and Swamy, "Solving an Empirical Puzzle in the Capital Asset Pricing Model," Office of the Comptroller of the Currency, E&PA Working Paper 97-10, June 1997

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