The Conditional CAPM and the Cross-Section of Expected Returns




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    • Jagannathan is from the Carlson School of Management, University of Minnesota; Hong Kong University of Science and Technology; and the Federal Reserve Bank of Minneapolis. Wang is from Columbia University. The authors benefited from discussions with S. Rao Aiyagari, Gordon Alexander, Michael Brennan, Charlie Calomiris, Mark Carhart, Eugene Fama, Wayne Ferson, Murray Frank, John Geweke, Lars Peter Hansen, Campbell Harvey, Pat Hess, Allan Kleidon, Peter Knez, Robert Korajczyk, Bruce Lehmann, Steve LeRoy, David Modest, Edward Prescott, Judy Rayburn, Richard Roll, Jay Shanken, Michael Sher, Stephen D. Smith, and Robert Stambaugh, as well as with participants at numerous finance workshops in the United States, Canada, and East Asia. Special thanks go to the anonymous referee and the managing editor of the journal for valuable comments. We are grateful to Eugene Fama for providing us with the Fama-French factors and Raymond A. Dragan for editorial assistance. All errors in this paper are the authors' responsibility. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Ravi Jagannathan gratefully acknowledges financial support from the National Science Foundation (grant SBR-9409824). Zhenyu Wang gratefully acknowledges financial support from the Alfred P. Sloan Foundation (doctoral dissertation fellowship, grant DD-518). An earlier version of the paper appeared under the title, “The CAPM Is Alive and Well.” The compressed archive of the data and the FORTRAN programs used for this paper can be obtained via anonymous FTP at The path is outgoing/wang/capm.tar.Z.


Most empirical studies of the static CAPM assume that betas remain constant over time and that the return on the value-weighted portfolio of all stocks is a proxy for the return on aggregate wealth. The general consensus is that the static CAPM is unable to explain satisfactorily the cross-section of average returns on stocks. We assume that the CAPM holds in a conditional sense, i.e., betas and the market risk premium vary over time. We include the return on human capital when measuring the return on aggregate wealth. Our specification performs well in explaining the cross-section of average returns.