The ICAPM and empirical pricing factors: A simulation study

초록

Many papers reporting new empirically-motivated pricing factors argue that the factors are based on the intertemporal capital asset pricing model (ICAPM) of Merton (1973). In the spirit of Fama's (1991) fishing license critique, Maio and Santa-Clara (2012) and Park and Sohn (2023) propose ways to test whether the pricing factors are consistent with the ICAPM. Unspecified, and thus unknown, state variables and conditional model features in the ICAPM complicate the empirical work; therefore, we conduct a simulation study that checks these methodologies in two different settings: the time-varying price of risk and time-varying betas. The method in Park and Sohn (2023), which nests that in Maio and Santa-Clara (2012) as a special case, does a great job in both settings.

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