Notes on "Assessing Asset Pricing Models Using" (Jonathan B. Berk, Jules H. van Binsbergen)

Assessing Asset Pricing Models Using Revealed Preference

Jonathan B. Berk

Stanford University and NBER

Jules H. van Binsbergen

University of Pennsylvania and NBER

March 14, 2015 Draft

• All neoclassical capital asset pricing models assume that investors compete fiercely with each other to find positive net present value investment opportunities, and in doing so, eliminate them. As a consequence of this competition, equilibrium prices are set so that the expected return of every asset is solely a function of its risk. When a positive net present value (NPV) investment opportunity present itself in capital markets investors react by submitting buy or sell orders until the opportunity no longer exist. These buy and sell orders reveal the preferences of investors and therefore they reveal which asset pricing model investors are using. By deserving whether or not buy and sell orders occur in reaction to the existence of positive net present value investment opportunities as defined by a particular asset pricing model, one can infer whether investors price risk using that asset pricing model:
• A mechanism that identifies positive NPV investment opportunities
• be able to observe investor reactions to these opportunities
• The core idea that undedies every neoclassical asset pricing model in economics is that prices are set by agents chasing positive NPV investment opportunities
• The key to designing a test to directly detect investor responses to positive NPV opportunities is to find an asset for which the price is fixed
• Berk and Green (2004)
• Berk and van Binsbergen (2013)
• At least some investors have access to different information or have different abilities to process information.

(Econometric process)

• The capital Asset Pricing Model
• A large number of potential return anomalies relative to that model have been uncovered
• These anomalies have motivated researchers to develop improved models that “explain” each anomaly as risk factor
• A new way of testing the validity of an asset pricing model:
• using mutual fund capital flow data
• Investors’ capital flows in and out of mutual funds does reliably distinguish between asset pricing models
• puzzles:
• poorly explain cross sectional variation in expected returns
• It is unclear why investors world finds investing in mutual funds attractive if they are the CAPM beta.
• what drives the fraction of flows that are unrelated to CAPM beta risk