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A Dynamic CAPM with Supply Effect: Theory and Empirical Results

In: HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING

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  • Cheng Few Lee
  • Chiung-Min Tsai
  • Alice C. Lee

Abstract

Breeden [An intertemporal asset pricing model with stochastic consumption and investment opportunities. Journal of Financial Economics 7, (1979) 265–296], Grinols [Production and risk leveling in the intertemporal capital asset pricing model. Journal of Finance 39, 5, (1984) 1571–1595] and Cox et al. [An intertemporal general equilibrium model of asset prices. Econometrica 53, (1985) 363–384] have described the importance of supply side for the capital asset pricing. Black [Rational response to shocks in a dynamic model of capital asset pricing. American Economic Review 66, (1976) 767–779] derives a dynamic, multiperiod CAPM, integrating endogenous demand and supply. However, Black’s theoretically elegant model has never been empirically tested for its implications in dynamic asset pricing. We first theoretically extend Black’s CAPM. Then we use price, dividend per share and earnings per share to test the existence of supply effect with US equity data. We find the supply effect is important in US domestic stock markets. This finding holds as we break the companies listed in the S&P 500 into 10 portfolios by different level of payout ratio. It also holds consistently if we use individual stock data. A simultaneous equation system is constructed through a standard structural form of a multiperiod equation to represent the dynamic relationship between supply and demand for capital assets. The equation system is exactly identified under our specification. Then, two hypothesis related to supply effect are tested regarding the parameters in the reduced-form system. The equation system is estimated by the seemingly unrelated regression (SUR) method, since SUR allows one to estimate the presented system simultaneously while accounting for the correlated errors.

Suggested Citation

  • Cheng Few Lee & Chiung-Min Tsai & Alice C. Lee, 2020. "A Dynamic CAPM with Supply Effect: Theory and Empirical Results," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 100, pages 3517-3544, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789811202391_0100
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    References listed on IDEAS

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    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. John Y. Campbell & Sanford J. Grossman & Jiang Wang, 1993. "Trading Volume and Serial Correlation in Stock Returns," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 108(4), pages 905-939.
    3. Black, Stanley W, 1976. "Rational Response to Shocks in a Dynamic Model of Capital Asset Pricing," American Economic Review, American Economic Association, vol. 66(5), pages 767-779, December.
    4. Amemiya, Takeshi, 1974. "A Note on a Fair and Jaffee Model," Econometrica, Econometric Society, vol. 42(4), pages 759-762, July.
    5. Lo, Andrew W & Wang, Jiang, 2000. "Trading Volume: Definitions, Data Analysis, and Implications of Portfolio Theory," The Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 257-300.
    6. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-384, March.
    7. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    8. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    9. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    10. Grinols, Earl L, 1984. "Production and Risk Leveling in the Intertemporal Capital Asset Pricing Model," Journal of Finance, American Finance Association, vol. 39(5), pages 1571-1595, December.
    11. Fair, Ray C & Jaffee, Dwight M, 1972. "Methods of Estimation for Markets in Disequilibrium," Econometrica, Econometric Society, vol. 40(3), pages 497-514, May.
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    Cited by:

    1. Mauro Andriotto & Emanuele Teti, 2014. "Beyond CAPM: an innovative factor model to optimize the risk and return trade-off," Journal of Business Economics and Management, Taylor & Francis Journals, vol. 15(4), pages 615-630, September.
    2. Yi-Cheng Shih & Sheng-Syan Chen & Cheng-Few Lee & Po-Jung Chen, 2014. "The evolution of capital asset pricing models," Review of Quantitative Finance and Accounting, Springer, vol. 42(3), pages 415-448, April.
    3. Peter C. Dawson, 2015. "The capital asset pricing model in economic perspective," Applied Economics, Taylor & Francis Journals, vol. 47(6), pages 569-598, February.

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    More about this item

    Keywords

    Financial Econometrics; Financial Mathematics; Financial Statistics; Financial Technology; Machine Learning; Covariance Regression; Cluster Effect; Option Bound; Dynamic Capital Budgeting; Big Data;
    All these keywords.

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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