A book-to-price characteristic is not a priced factor until a test says so, and the test is a
portfolio an investor could have held. The security market line and the classic CAPM tests already record the equilibrium
restrictions and the historical verdicts. This note designs the experiment those lessons assume:
which hypotheses are joint, which market proxy enters the regression, and why one bad year for
high-beta stocks is not a rejection.
Learning objectives. By the end of this note you should be able to:
- write the three hypotheses that are tested together whenever realised returns stand in for expectations;
- state the restrictions that separate the standard CAPM from the zero-beta form;
- specify a beta-decile strategy that an investor could have followed, and read an intercept above the Treasury-bill rate as evidence about which form fits;
- explain why the same pricing equation can be rejected or supported once the market proxy changes, and what Roll's tautology does to that reading.
In this lesson
- The object under test
- A strategy the investor could have held
- The proxy is part of the hypothesis
- The same equation under a different measurement
- What a large pricing error means for the book
Before you start
- CAPM: The Security Market Line and Beta Pricing
- Empirical Tests of the CAPM and Roll's Critique
- Non-Standard CAPM Forms: Zero-Beta, Taxes, and Multi-Beta
The full lesson, with worked examples and exercise solutions, is for members.
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