Behavioural heterogeneity in the capital asset pricing model with an application to the low-beta anomaly

Abstract

ABSTRACT This study extends the capital asset pricing model (CAPM) to situations where a subset of investors is not the mean-variance optimizers. The security market line (SML) relationship of the CAPM is shown to hold when beta is suitably adjusted in the presence of such investors. The adjusted CAPM is then used to show which of the non-mean-variance behaviour is needed to explain the so-called CAPM anomalies. For instance, the adjusted CAPM explains the low-beta anomaly if the non-mean-variance investors overweight (underweight) the high-beta (low-beta) assets. Interestingly, the empirical analysis showed that two-thirds of the investors are needed to deviate from the mean-variance analysis in order to explain the low-beta anomaly.