A multi-period asset pricing model: implication for size and book-to-market effect

Abstract

In light of the inadequacy of Sharpe's one-period Capital Asset Pricing Model (CAPM) in explaining stock returns, this paper develops a multi-period two-factor model that incorporates growth in earnings as an additional factor besides beta. This suggests that Sharpe's CAPM may be misspecified due to the omission of the earnings growth variable. In addition, it may explain why size and book-to-market effects are significant since earnings growth and the two factors are highly correlated.