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2023 | OriginalPaper | Chapter

6. Alternative CAPM Specifications

Authors : James W. Kolari, Seppo Pynnönen

Published in: Investment Valuation and Asset Pricing

Publisher: Springer International Publishing

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Abstract

Weak early empirical evidence with respect to the CAPM inspired a variety of alternative forms proposed by researchers to take into account realistic aspects of capital markets not considered in its original form. In the last chapter we covered Black’s (1972) zero-beta CAPM allowing short sales and borrowing at rates greater than the riskless rate. Here we review further extensions of the CAPM, including the foundational and more general intertemporal CAPM (ICAPM) which spawned a number of new models such as the international asset pricing model (IAPM), consumption CAPM (CCAPM), production CAPM (PCAPM), and conditional CAPM.

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previous chapter The Zero-Beta CAPM

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Merton cited Fama (1970), who had observed that intertemporal portfolio maximization can be treated as if the investor had a single-period utility function.

Browning motion in physics is the random motion of particles.

See equation (34) in Merton (1973, p. 882). The derivation of this model is quite complicated and beyond the scope of the present text. He utilized stochastic differential calculus, complex continuous functions, instantaneous returns (as opposed to discrete one-period returns), and optimality conditions to solve the asset pricing problem.

For an excellent survey of the issue of domestic (local) versus global asset pricing, see Karolyi and Stulz (2002).

If \(R_{xt}>0\), we can infer a depreciation of the dollar against the euro, as each euro can buy more dollars at time t than before at time \(t-1\). If \(R_{xt}<0\), then the dollar appreciated against the euro.

A more widely used currency basket by the IMF is the Special Drawing Right (SDR) consisting of currencies in the United States, Europe, Japan, and the United Kingdom. The Federal Reserve in the United States constructs a number of other currency baskets. In general, currency baskets are formed using trade weights of the different exchange rates.

Also, he tested a five-factor model by Chen et al. (1986) that contains the growth in industrial production and some inflation and interest rate variables. Like the CAPM, the performance of this multifactor model was similar to the PCAPM.