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Explaining the Failure of the Unconditional CAPM with the Conditional CAPM

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Listed:
  • Michael Hasler

    (Naveen Jindal School of Management, University of Texas at Dallas, Richardson, Texas 75080)

  • Charles Martineau

    (Rotman School of Management and UTSC Management, University of Toronto, Toronto, Ontario M5S 3E6, Canada)

Abstract

When the cost of hedging is nil, the conditional capital asset pricing model (CAPM) holds. We empirically test the conditional CAPM by regressing asset returns onto the product of their conditional betas and market returns. Estimated intercepts are not statistically different from zero, implying that the conditional CAPM successfully explains the conditional level of asset returns. Yet, unconditional betas do not explain the cross section of average asset returns; the unconditional CAPM fails. We show why and how the success of the conditional CAPM actually explains the failure of the unconditional CAPM, thereby rationalizing the coexistence of these two intriguing results.

Suggested Citation

  • Michael Hasler & Charles Martineau, 2023. "Explaining the Failure of the Unconditional CAPM with the Conditional CAPM," Management Science, INFORMS, vol. 69(3), pages 1835-1855, March.
    • Handle: RePEc:inm:ormnsc:v:69:y:2023:i:3:p:1835-1855
    DOI: 10.1287/mnsc.2022.4381
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