Unconditional Asset Pricing When Betas Covary with the Riskless Rate
54 Pages Posted: 1 Oct 2015 Last revised: 24 Aug 2017
Date Written: June 2, 2016
Abstract
I show that the covariance of betas with riskless rates, referred to as “kappa,” is an important determinant of average returns. Absence of arbitrage implies that average excess returns equal kappa plus the product of expected beta and the average riskless rate. Implementing this relation for the CAPM and ICAPM, I find a remarkable improvement. In striking contrast to extant evidence, an unconditional CAPM with two factors (corresponding to expected beta and kappa) explains 58% of the cross section of returns for 175 anomaly-based portfolios. Further modeling suggests kappa is related to firm size, idiosyncratic operating profitability, and growth rates.
Keywords: Conditional asset pricing; CAPM; Riskless rate; Conditioning information; Size premium; Value premium; Gross profitability premium; Low beta anomaly
JEL Classification: G12; E44
Suggested Citation: Suggested Citation