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Linear Beta Pricing with Inefficient Benchmarks

Author

Listed:
  • George Diacogiannis

    (Department of Banking and Financial Management, University of Piraeus, Greece;
    School of Management, University of Bath, UK)

  • David Feldman

    (Banking and Finance, University of New South Wales, Australia)

Abstract

Current asset pricing models require mean-variance efficient benchmarks, which are generally unavailable because of partial securitization and free float restrictions. We provide a pricing model that uses inefficient benchmarks, a two-beta model, one induced by the benchmark and one adjusting for its inefficiency. While efficient benchmarks induce zero-beta portfolios of thesameexpected return,anyinefficient benchmark induces infinitely many zero-beta portfolios atallexpected returns. These make market risk premiums empirically unidentifiable and explain empirically found dead betas and negative market risk premiums. We characterize other misspecifications that arise when using inefficient benchmarks with models that require efficient ones. We provide a space geometry description and analysis of the specifications and misspecifications. We enhance Roll (1980), Roll and Ross's (1994), and Kandel and Stambaugh's (1995) results by offering a "Two Fund Theorem," and by showing the existence of strict theoretical "zero relations" everywhere inside the portfolio frontier.

Suggested Citation

  • George Diacogiannis & David Feldman, 2013. "Linear Beta Pricing with Inefficient Benchmarks," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 3(01), pages 1-35.
  • Handle: RePEc:wsi:qjfxxx:v:03:y:2013:i:01:n:s2010139213500043
    DOI: 10.1142/S2010139213500043
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    Citations

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    Cited by:

    1. Syed Jawad Hussain Shahzad, 2015. "Multiscale Systematic Risk: Empirical Evidence from Pakistan," International Journal of Economics and Empirical Research (IJEER), The Economics and Social Development Organization (TESDO), vol. 3(12), pages 605-615, December.
    2. Thomas A. Severini, 2015. "A note on the effects of market inefficiency and portfolio constraints on the relationship between the expected return of an asset and the market," Economics and Business Letters, Oviedo University Press, vol. 4(4), pages 175-182.
    3. Shahzad, Syed Jawad Hussain & Zakaria, Muhammad & Raza, Naveed, 2014. "Sensitivity Analysis of CAPM Estimates: Data Frequency and Time Frame," MPRA Paper 60110, University Library of Munich, Germany.
    4. Syed Jawad Hussain Shahzad & Saniya Khalid & Saba Ameer, 2016. "CAPM estimates: Can data frequency and time period lend a hand?," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(02), pages 1-12, June.
    5. Diacogiannis, George & Ioannidis, Christos, 2022. "Linear beta pricing with efficient/inefficient benchmarks and short-selling restrictions," International Review of Financial Analysis, Elsevier, vol. 81(C).

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