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Capital Asset Pricing with a Stochastic Horizon

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  • Brennan, Michael J.
  • Zhang, Yuzhao

Abstract

In this paper we present empirical tests of an extended version of the capital asset pricing model (CAPM) that replaces the single-period horizon with a probability distribution over different horizons. Adopting a simple parameterization of the probability distribution of the length of the horizon, we estimate the parameters of the distribution as well as the parameters of the CAPM. We find that the extended model is not rejected for several different samples of common stocks, and for these samples it outperforms not only the standard CAPM but also the Fama–French (1993) 3-factor model. The probability distribution over horizon dates varies over time with the New York Stock Exchange (NYSE) turnover rate. We also find that returns satisfy the Euler equation of a representative financial institution that holds the market portfolio and has horizon probabilities estimated from 13F filings.

Suggested Citation

  • Brennan, Michael J. & Zhang, Yuzhao, 2020. "Capital Asset Pricing with a Stochastic Horizon," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 55(3), pages 783-827, May.
    • Handle: RePEc:cup:jfinqa:v:55:y:2020:i:3:p:783-827_3
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    Cited by:

    1. Chenglu Jin & Thomas Conlon & John Cotter, 2023. "Co-Skewness across Return Horizons," Journal of Financial Econometrics, Oxford University Press, vol. 21(5), pages 1483-1518.
    2. Dong, Dayong & Wu, Keke & Fang, Jianchun & Gozgor, Giray & Yan, Cheng, 2022. "Investor attention factors and stock returns: Evidence from China," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).
    3. Ryuta Sakemoto, 2022. "Multi‐scale inter‐temporal capital asset pricing model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(4), pages 4298-4317, October.
    4. Brennan, M.J. & Taylor, Alex P., 2023. "Expected returns and risk in the stock market," Journal of Empirical Finance, Elsevier, vol. 72(C), pages 276-300.

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