Jagannathan and Wang (1996). Testing the Conditional CAPM. The Story. When we test the static CAPM we find that We can’t explain the cross-sectional variation in expected returns well at all. Other variables add explanatory power, when they should not: Size Book-to-Market
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Jagannathan and Wang (1996)
Testing the Conditional CAPM
where 1 is the market risk premium.
where i,t-1 is the conditional market beta of asset i
where 1 is the unconditional expected market risk premium and is the unconditional expected beta.
and then
The linearity is preserved because covariance is a linear operation and the actual conditional market risk premium is assumed to be linear in the proxy.
and then
and csize should be zero under the null.
where 0, vw, prem, and labor are
and