Journal
REVIEW OF ASSET PRICING STUDIES
Volume 10, Issue 2, Pages 290-334Publisher
OXFORD UNIV PRESS
DOI: 10.1093/rapstu/raz005
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I test a number of well-known asset pricing models using regression-based managed portfolios that capture nonlinearity in the cross-sectional relation between firm characteristics and expected stock returns. Although the average portfolio returns point to substantial nonlinearity in the data, none of the asset pricing models successfully explain the estimated nonlinear effects. Indeed, the estimated expected returns produced by the models display almost no variation across portfolios. Because the tests soundly reject every model considered, it is apparent that nonlinearity in the relation between firm characteristics and expected stock returns poses a formidable challenge to asset pricing theory.
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