Asset pricing in a multi-factor setting

Abstract

We mathematically show that no matter how many factors are augmented to Capital Asset Pricing Model (CAPM), beta will always matter. We also show that augmenting additional factors to single-factor CAPM requires market risk premia to be modeled as time-varying. In addition to allowing a time-varying market risk premia, our methodology may be extended to allow for time-varying systemic risk. Our approach offers a fairly simple way of estimating expected excess returns in a multi-factor setting without calling upon the sorting methodologies.