Misspecification of capital asset pricing model (CAPM): implication for size and book-to-market effects

Since the pioneering work of Markowitz (1952) in the normative portfolio selection and the development of Capital Asset Pricing Model (CAPM) by Sharpe (1964). Lintner (1965) and Mossin (1966), a vast amount of empirical work has been done to verify or refute this model. Initial empirical tests such as those by Black, Jensen and Scholes (1972) and Fama and Macbeth (1973, 1974) have focused on the intercept, slope and the linear relationship between a security's expected retum and its beta. Although some support is found for the model in that no significant nonlinearities and unsystematic risk exist, it does not validate the theoretical relationship because the slope of beta estimates tend to be flatter and the intercept higher (i.e., Black's zero beta concept) than the model predicts.