Linear beta pricing with inefficient benchmarks in a given factor structure*

George Diacogiannis, Christos Ioannidis*

*Corresponding author for this work

Research output: Contribution to journalArticle

Abstract

We show the equivalence between the zero-beta version of a multi-factor arbitrage pricing model and a linear pricing model utilizing undiversified inefficient benchmarks in a given factor structure. The resulting linear model is a two-beta model, with one beta related to the inefficient benchmark and another adjusting for its inefficiency. This linear model shows that there are only two distinctive and computable sources of risk, affecting security expected returns, despite the existence of several risk factors. In a short empirical example we demonstrate that the model can be employed to provide guidance and allow researchers to test for the validity of their selection of the underlying risk factors driving variations in security returns.

Original languageEnglish
Pages (from-to)1551-1571
Number of pages21
JournalEuropean Journal of Finance
Volume25
Issue number16
Early online date16 Jul 2019
DOIs
Publication statusE-pub ahead of print - 16 Jul 2019

Bibliographical note

This is an Accepted Manuscript of an article published by Taylor & Francis Group in European Journal of Finance on 16 July 2019, available online at: http://www.tandfonline.com/10.1080/1351847X.2019.1639207

Keywords

  • asset pricing
  • bond interest rates
  • General portfolio choice
  • investment decisions
  • trading volume

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