DP12607 The Lost Capital Asset Pricing Model

Author(s): Daniel Andrei, Julien Cujean, Mungo Wilson
Publication Date: January 2018
Keyword(s):
JEL(s):
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12607

A flat Securities Market Line is not evidence against the CAPM. Under the Roll (1977) critique, the CAPM is a "lost city of Atlantis," empirically invisible. In a noisy rational-expectations economy, there exists an information gap between the average investor who holds the market and the empiricist who does not observe the market portfolio. The CAPM holds for the investor, but appears flat to the empiricist. This distortion is empirically substantial and explains, for instance, why "Betting Against Beta" works; BAB really bets on true beta. Macroeconomic announcements reduce the distortion---for a fleeting moment the empiricist catches a glimpse of the CAPM.