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w-MPS risk aversion and the shadow CAPM: theory and empirical evidence

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  • Lin Huang
  • Chenghu Ma
  • Hiroyuki Nakata

Abstract

This paper presents the shadow capital asset pricing model (CAPM) of Ma [2011a. Advanced Asset Pricing Theory. London: Imperial College Press] as an intertemporal equilibrium asset pricing model, and tests it empirically. In contrast to the classical CAPM – a single-factor model based on a strong behavioral or distributional assumption – the shadow CAPM can be represented as a two-factor model, and only requires a modest behavioral assumption of weak form mean-preserving spread risk aversion. The empirical tests provide support in favor of the shadow CAPM over the classical CAPM, the consumption CAPM, or the Epstein and Zin [1991. “Substitution, Risk Aversion and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis”. Journal of Political Economy 99, 263–286] model. Moreover, the shadow CAPM provides a consistent explanation for the cross-sectional variations of expected returns on the stocks and for the time-varying equity premium.

Suggested Citation

  • Lin Huang & Chenghu Ma & Hiroyuki Nakata, 2017. "w-MPS risk aversion and the shadow CAPM: theory and empirical evidence," The European Journal of Finance, Taylor & Francis Journals, vol. 23(11), pages 947-973, September.
    • Handle: RePEc:taf:eurjfi:v:23:y:2017:i:11:p:947-973
    DOI: 10.1080/1351847X.2015.1082495
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