Agency-Based Asset Pricing and the Beta Anomaly

Abstract

I argue that delegated portfolio management can cause the equilibrium relation between CAPM beta and expected stock returns to become flat, instead of linearly positive, and propose an alternative to the widely used Fama and French (1993) 3-factor asset pricing model which incorporates this agency effect. An empirical comparison of the two models shows that the agency-based 3-factor model is much better at explaining the performance of portfolios sorted on beta or volatility, and at least as good at explaining the performance of various other test portfolios, including those the original 3-factor model was designed to explain. These results are consistent with empirical studies which have previously established that market beta does not appear to be a priced risk factor in the cross-section of stock returns.

Keywords: asset pricing, beta anomaly, volatility anomaly, Fama-French 3-factor model, agency problems, delegated portfolio management

JEL Classification: C12, G11, G12, G14