Unconditional Asset Pricing When Betas Covary with the Riskless Rate

54 Pages Posted: 1 Oct 2015 Last revised: 24 Aug 2017

See all articles by Konark Saxena

Konark Saxena

University of New South Wales

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

Saxena, Konark, Unconditional Asset Pricing When Betas Covary with the Riskless Rate (June 2, 2016). Available at SSRN: https://ssrn.com/abstract=2667504 or http://dx.doi.org/10.2139/ssrn.2667504

Konark Saxena (Contact Author)

University of New South Wales ( email )

School of Banking and Finance
Australian School of Business
Sydney, NSW 2052
Australia

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