Why can the empirical evidence for book-to-market and size effects be treated as a violation to...

Why can the empirical evidence for book-to-market and size effects be treated as a violation to the CAPM?

Expert Solution

Tests of the significance of the book-to-market ratio (BE/ME) and its their market value (MVE) or size has a negative effects on establishment for thought of CAPM, which suffers two potentially serious shortcomings.

1. use variations of the CAPM to represent precise risk.As an outcome, these tests rely upon a particular benchmark model. In the event that an inappropriate benchmark is picked, at that point contrasts in normal returns (or hazard premium) might be mistakenly ascribed to the presence BE/ME or MVE impacts. Proof that rejects the CAPM is basic in the writing, and there is no settled upon observational model to supplant it. In this way, it is critical to build tests that don't depend on a particular resource evaluating model.

2.deficiency is that the vast majority of the detailed tests use OLS strategy. It is, best case scenario far fetched that these tests fulfill the OLS prerequisite that the logical factors are autonomous of the LHS variable, on the grounds that the tried portfolios comprise a noteworthy segment of the informative variable, the market record.

jeff jeffy answered 2 days ago

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