On the power of cross-sectional and multivariate tests of the CAPM |
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Authors: | Robert R. Grauer Johannus A. Janmaat |
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Affiliation: | 1. Faculty of Business Administration, Simon Fraser University, Burnaby, British Columbia, Canada V5A 1S6;2. Barber School of Arts and Sciences, University of British Columbia – Okanagan, Kelowna, British Columbia, Canada V1V 1V7 |
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Abstract: | This paper examines the power of the cross-sectional and multivariate tests of the CAPM under ideal conditions. When the CAPM is true the positively weighted market portfolio is MV-efficient and securities plot on the security market line. When the CAPM is false an alternative asset pricing model determines prices. An examination of the population intercepts, slopes and R2 from cross-sectional regressions of expected returns on betas indicates that all three are unreliable indicators of whether the CAPM holds. Simulation analysis of the power of the cross-sectional tests expands on and reinforces the analysis based on the population values. The Gibbons et al. (1989) multivariate test fares much better. |
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Keywords: | G11 G12 C1 |
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