Using Expectations to Test Asset Pricing Models


  • We thank Yakov Amihud, Malcolm Baker, Ravi Bansal, Brad Barber, Larry Blume, Kobi Boudoukh, Markus Brunnermeier, Peter Demerjian, Magnus Dahlquist, Wayne Ferson, John Graham, Campbell Harvey, J.B. Heaton, Matt Richardson, Jay Shanken, Hersh Shefrin, Andrei Shleifer, Meir Statman, Avanidhar Subrahmanyam, seminar participants at Cornell University, Columbia University, Duke University, Emory University, Harvard Business School, the Interdisciplinary Center Herzlyia, Israel, Michigan State University, MIT, New York University, Rice University, Tel-Aviv University, Texas Christian University, Tulane University, Tuck School of Business at Dartmouth, The Wharton School, University of British Columbia, University of California Berkeley, University of Chicago, University of Colorado at Boulder, University of Florida, University of Haifa, University of Rochester, University of Washington, Seattle, University of Wisconsin, Madison, Vanderbilt University, Washington University in St. Louis, Yale University, the 2003 Western Finance Association meetings in Los Cabos, Mexico, the 2003 Utah Winter Finance Conference, and John Nugent from Value Line Institutional Services for their comments. We owe special thanks to Michael Roberts for his suggestions.


Asset pricing models generate predictions relating assets' expected rates of return and their risk attributes. Most tests of these models have employed realized rates of return as a proxy for expected return. We use analysts' expected rates of return to examine the relation between these expectations and firm attributes. By assuming that analysts' expectations are unbiased estimates of market-wide expected rates of return, we can circumvent the use of realized rates of return and provide evidence on the predictions emanating from traditional asset pricing models. We find a positive, robust relation between expected return and market beta and a negative relation between expected return and firm size, consistent with the notion that these are risk factors. We do not find that high book-to-market firms are expected to earn higher returns than low book-to-market firms, inconsistent with the notion that book-to-market is a risk factor.