A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory |
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Authors: | Richard Roll |
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Institution: | University of California, Los Angeles, CA 90024, U.S.A. |
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Abstract: | Testing the two-parameter asset pricing theory is difficult (and currently infeasible). Due to a mathematical equivalence between the individual return/‘beta’ linearity relation and the market portfolio's mean-variance efficiency, any valid test presupposes complete knowledge of the true market portfolio's composition. This implies, inter alia, that every individual asset must be included in a correct test. Errors of inference inducible by incomplete tests are discussed and some ambiguities in published tests are explained. |
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