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Beta in Linear Risk Tolerance Economies

Author

Listed:
  • Robert R. Grauer

    (Department of Economics, Simon Fraser University, Burnaby, British Columbia, Canada V5A 1S6)

Abstract

This paper employs numerical means to examine: (i) the expected return-beta plot in power utility Linear Risk Tolerance (LRT) economies, and (ii) whether, in the power utility economies, a valuation equation containing covariance and coskewness terms might better explain expected returns than one containing covariance terms alone. The results show that the expected return-beta plots constructed from real world return distributions are very similar to the plots found in empirical tests of the Mean Variance Capital Asset Pricing Model (MV CAPM). Hence a power utility LRT CAPM may provide a better theory of asset pricing than the MV CAPM does. While beta is not the correct measure of risk in power utility LRT economies, the results show that on average a valuation equation containing covariance terms only explains expected returns better than a valuation equation containing both covariance and coskewness terms.

Suggested Citation

  • Robert R. Grauer, 1985. "Beta in Linear Risk Tolerance Economies," Management Science, INFORMS, vol. 31(11), pages 1390-1402, November.
    • Handle: RePEc:inm:ormnsc:v:31:y:1985:i:11:p:1390-1402
    DOI: 10.1287/mnsc.31.11.1390
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    Cited by:

    1. Michael J. Best & Xili Zhang, 2011. "Degeneracy Resolution for Bilinear Utility Functions," Journal of Optimization Theory and Applications, Springer, vol. 150(3), pages 615-634, September.

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