Personal Asset Pricing and the Premium Investment Framework

Abstract

Rational asset pricing models should hold across assets. Nevertheless, in practice they are often developed and tested on a single asset pricing anomaly. This approach can lead to an overabundance of idiosyncratic ‘rational’ explanations. The paper demonstrates the problem by showing that crash and recession risk are idiosyncratic to a set of anomalies and consequently invalid as rational explanations. However, even with appropriate empirical testing, our ability to find a rational model is additionally hindered by the benchmark ambiguity and joint hypothesis problems. The paper discusses personal asset pricing as an alternative to equilibrium testing when investment recommendations are required.

Keywords: Anomaly evaluation, recession risk, crash risk, alpha decay, investor heterogeneity

JEL Classification: G10, G11, G12