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2015 | OriginalPaper | Buchkapitel

93. A Dynamic CAPM with Supply Effect Theory and Empirical Results

verfasst von : Cheng-Few Lee, Chiung-Min Tsai, Alice C. Lee

Erschienen in: Handbook of Financial Econometrics and Statistics

Verlag: Springer New York

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Abstract

Breeden (1979) and Grinols (1984) and Cox et al. (1985) have described the importance of supply side for the capital asset pricing. Black (1976) derives a dynamic, multiperiod CAPM, integrating endogenous demand and supply. However, Black’s theoretically elegant model has never been empirically tested for its implications in dynamic asset pricing. We first theoretically extend Black’s CAPM. Then, we use price, dividend per share, and earnings per share to test the existence of supply effect with US equity data. We find the supply effect is important in US domestic stock markets. This finding holds as we break the companies listed in the S&P 500 into ten portfolios by different level of payout ratio. It also holds consistently if we use individual stock data.

A simultaneous equation system is constructed through a standard structural form of a multiperiod equation to represent the dynamic relationship between supply and demand for capital assets. The equation system is exactly identified under our specification. Then, two hypotheses related to supply effect are tested regarding the parameters in the reduced form system. The equation system is estimated by the seemingly unrelated regression (SUR) method, since SUR allow one to estimate the presented system simultaneously while accounting for the correlated errors.

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This dynamic asset pricing model is different from Merton’s (1973) intertemporal asset pricing model in two key aspects. First, Black’s model is derived in the form of simultaneous equations. Second, Black’s model is derived in terms of price change, and Merton’s model is derived in terms of rates of return.

It should be noted that Lo and Wang’s model did not explicitly introduce the supply equation in asset pricing determination. Also, one can identify the hedging portfolio using volume data in the Lo and Wang model setting.

The basic assumptions are as follows: (1) a single period moving horizon for all investors; (2) no transaction costs or taxes on individuals; (3) the existence of a risk-free asset with rate of return, r*; (4) evaluation of the uncertain returns from investments in terms of expected return and variance of end-of-period wealth; and (5) unlimited short sales or borrowing of the risk-free asset.

Theories as to why taxes and penalties affect capital structure are first proposed by Modigliani and Miller (1958) and then Miller (1977). Another market imperfection, prohibition on short sales of securities, can generate “shadow risk premiums” and, thus, provide further incentives for firms to reduce the cost of capital by diversifying their securities.

The identification of the simultaneous equation system can be found in Appendix 2.

s _ij is the ith row and jth column of the variance-covariance matrix of return. a _i and b _i are the supply adjustment cost of firm i and overall cost of capital of firm i, respectively.

The results are similar when using either the FIML or SUR approach. We report here the estimates of the SUR method.

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Titel: A Dynamic CAPM with Supply Effect Theory and Empirical Results
verfasst von: Cheng-Few Lee
Chiung-Min Tsai
Alice C. Lee
Verlag: Springer New York
Buch: Handbook of Financial Econometrics and Statistics
Print ISBN: 978-1-4614-7749-5

Electronic ISBN: 978-1-4614-7750-1

Copyright-Jahr: 2015
DOI: https://doi.org/10.1007/978-1-4614-7750-1_93