Journal Of The Econometric Society

An International Society for the Advancement of Economic
Theory in its Relation to Statistics and Mathematics

Edited by: Guido W. Imbens • Print ISSN: 0012-9682 • Online ISSN: 1468-0262

Econometrica: Jul, 2007, Volume 75, Issue 4

Prices and Portfolio Choices in Financial Markets: Theory, Econometrics, Experiments
p. 993-1038

Peter Bossaerts, Charles Plott, William R. Zame

Many tests of asset‐pricing models address only the pricing predictions, but these pricing predictions rest on portfolio choice predictions that seem obviously wrong. This paper suggests a new approach to asset pricing and portfolio choices based on unobserved heterogeneity. This approach yields the standard pricing conclusions of classical models but is consistent with very different portfolio choices. Novel econometric tests link the price and portfolio predictions and take into account the general equilibrium effects of sample‐size bias. This paper works through the approach in detail for the case of the classical capital asset pricing model (CAPM), producing a model called CAPM+ε. When these econometric tests are applied to data generated by large‐scale laboratory asset markets that reveal both prices and portfolio choices, CAPM+εis not rejected.

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