S-Space College of Business Administration/Business School (경영대학/대학원) Dept. of Business Administration (경영학과) Seoul Journal of Business (SJB) Seoul Journal of Business Volume 22, Number 1/2 (2016)
Why Do Some Asset Pricing Models Perform Poorly? Evidence from Irrationality, Transaction Costs, and Missing Factors
- Issue Date
- Seoul Journal of Business, Vol.22 No.1, pp. 1-64
- Asset Pricing Model ; Transaction Cost ; Investor irrationality ; Missing Risk Factor ; Fama and MacBeth (1973) Regression
- We identify and horse race three causes for the underperformance of some asset pricing models: investor irrationality, transaction costs, and missing risk factors. Specifically, we regress the difference of realized over expected returns (pricing error) per various asset pricing models onto proxies for the reasons for explanatory breakdown. First, for the capital asset pricing model (CAPM) and six other models we find that both investor irrationality and transaction costs are significantly related to the pricing error controlling for firm size and valuation. Second, models with more risk factors than the CAPM cannot overcome the shortcoming of the CAPM due to investor irrationality and transaction costs. In conclusion, transaction costs and investor irrationality are shown to be impediments to enhancing the prediction power of tested models regardless of additional risk factors.
- Files in This Item: