Articlebronze2004

Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing

Michael John Brennan · Ashley Wang · Yihong Xia

328 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Stochastic processes and financial applications Economic theories and models

Abstract

ABSTRACT A simple valuation model with time‐varying investment opportunities is developed and estimated. The model assumes that the investment opportunity set is completely described by the real interest rate and the maximum Sharpe ratio, which follow correlated Ornstein–Uhlenbeck processes. The model parameters and time series of the state variables are estimated using U.S. Treasury bond yields and expected inflation from January 1952 to December 2000, and as predicted, the estimated maximum Sharpe ratio is related to the equity premium. In cross‐sectional asset‐pricing tests, both state variables have significant risk premia, which is consistent with Merton's ICAPM.

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References

1993Common risk factors in the returns on stocks and bonds 1976The arbitrage theory of capital asset pricing 1996Multifactor Explanations of Asset Pricing Anomalies 1973An Intertemporal Capital Asset Pricing Model 1977An equilibrium characterization of the term structure 1997Industry costs of equity 1991Efficient Capital Markets: II 1986Economic Forces and the Stock Market

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2015Earnings Announcements and Systematic Risk 2010The intertemporal capital asset pricing model with dynamic conditional correlations 2006Yield Spreads as Alternative Risk Factors for Size and Book-to-Market 2011Conference Presentations and the Disclosure Milieu 2012Multifactor models and their consistency with the ICAPM 2011The term structures of equity and interest rates 2007Asymmetric stock market volatility and the cyclical behavior of expected returns

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