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A Concave Security Market Line

Enrico De Giorgi, Thierry Post & Atakan Yalcin

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abstract We provide theoretical and empirical arguments in favor of a concave shape for the security market line, or a diminishing marginal premium for market risk. In capital market equilibrium with binding portfolio restrictions, different investors generally hold different sets of risky securities. Despite the differences in composition, the optimal portfolios generally share a joint exposure to systematic risk. Equilibrium in this case can be approximated by a concave relation between expected return and market beta rather than the traditional linear relation. An empirical analysis of U.S. stock market data confirms the existence of a significant and robust, concave cross-sectional relation between average return and estimated past market beta. We estimate that the market-risk premium is at least five to six percent per annum for the average stock, substantially higher than conventional estimates.
   
type working paper (English)
   
keywords capital market equilibrium, asset pricing, investment restrictions, portfolio theory
   
project Applying Recent Developments in Computational Statistics to Behavioral Asset Pricing and Portfolio Selection
date of appearance 2012
publisher http://ssrn.com/abstract=1800229
review not reviewed
   
citation De Giorgi, E., Post, T., & Yalcin, A. (2012). A Concave Security Market Line: http://ssrn.com/abstract=1800229.