Article1982

Evidence on a Simplified Model of Systematic Risk

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Abstract

ics in finance and accounting. Empirical analyses have examined correlations between accounting variables and beta [1, 2, 3, 9, 11], the association between macroeconomic factors and beta [26], and the relationship between operating and/or financial leverage and beta [5, 10, 12]. More commonly seen in the literature is the multiple regression model of beta as a function of numerous accounting variables and ad hoc proxies for other possible determinants [4, 6, 13, 16, 18, 19, 25, 28, 31]. Unfortunately, the somewhat inconsistent results of those studies are not clearly reconcilable into a unified profile of the determinants of systematic risk. An econometric explanation is not easy. In multiple regression studies such as Breen and Lerer [6], the presence of numerous accounting variables in a single model creates possibilities of obscuring the effects of any appropriately specified variables. Furthermore, it is not at all clear which, if any, of such variables should be tested at all. The firm's systematic risk should be related to the underlying activities of the firm [27], but without a rigorous theoretical model, testing the effects of such variables is not a promising route. For example, Rosenberg and McKibben [28], Pettit and Westerfield [25], and Thompson [31] all developed statistical models relating beta to financial variables, and while their results were interesting, in each case it could be said that the data were in search of a theory. Myers [23] recently attempted to provide a theory in which investor predictions of cash flows were generated by an adaptive expectations model. Solving this multi-period problem confirmed his suspicions that cyclicality, growth, and earnings volatility were determinants of beta. Turbull [32] set up a model where firm value is stochastically generated by a Geometric Brownian motion process. He found that beta was determined by growth of expected cash flows, duration

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1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1958The Cost of Capital, Corporation Finance and the Theory of Investment 1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]1963CORPORATE INCOME TAXES AND THE COST OF CAPITAL: A CORRECTION 1977DEBT AND TAXES*1980Financial Theory and Corporate Policy.1976The option pricing model and the risk factor of stock 1979The effect of personal taxes and dividends on capital asset prices

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