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Capital Asset Pricing with Price Level Changes

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  • Hagerman, Robert L.
  • Kim, E. Han

Abstract

A capital asset-pricing model which relates risk and return under conditions of changing price levels has been developed in this paper. The resulting model implies that price-level changes do not affect the expected real returns on individual assets except through their impact on the return of the market portfolio. If real market returns are independent of price-level movements, the model is very much like the standard capital asset-pricing model expressed in real returns. This version of the capital asset-pricing model does not, however, resolve all the difficulties associated with changing price levels, since we have assumed that the nominal default-free rate is determined outside the model and that relative prices do not change. These limitations, however, also apply to all other single-period capital asset-pricing models.In addition, the model was converted into nominal returns by assuming that price-level changes and the real market returns are uncorrelated. The resulting equation illustrates the difficulty involved in using nominal returns to test a model expressed in real returns. The same equation also provides a possible explanation for the noted discrepancies between the empirical' evidence found by Black, Jensen, and Scholes [3] and the prediction of the traditional capital asset-pricing model.

Suggested Citation

  • Hagerman, Robert L. & Kim, E. Han, 1976. "Capital Asset Pricing with Price Level Changes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 11(3), pages 381-391, September.
  • Handle: RePEc:cup:jfinqa:v:11:y:1976:i:03:p:381-391_02
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    Cited by:

    1. Berck, Peter & Cecchetti, Stephen G, 1980. "Portfolio Choice with Uncertain Consumption Prices: a mean-variance approch," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt38t9z8b9, Department of Agricultural & Resource Economics, UC Berkeley.
    2. J.A. Schnabel, 1980. "A Note On Inflation, The Capital Asset Pricing Model, And Beta Estimation With Nominal Data," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 3(3), pages 261-267, September.
    3. Wilbur G. Lewellen & James S. Ang, 1982. "Inflation, Security Values, And Risk Premia," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 5(2), pages 105-123, June.
    4. Berck, Peter & Cecchetti, Stephen G, 1980. "Portfolio Choice with Uncertain Consumption Prices: a mean-variance approch," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt38t9z8b9, Department of Agricultural & Resource Economics, UC Berkeley.

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