General Capital Asset Pricing Model (GCAPM) - A Microeconomic Theory of Investments

Abstract

The traditional CAPM can not explain empirically flat beta risk premiums and pronounced equity style effects. This paper proposes a new capital asset pricing model - GCAPM, which restores the invisible hand of markets as the sole mechanism for any competitive capital market equilibriums. GCAPM firmly links capital asset pricing with investors' time-variant and heterogeneous investment objectives, risk concerns, and asset valuations. It bestows modern finance paradigms with broader definitions and richer economic contents. It shows that, under the new light, CAPM paradigms are alive and well, independent of its framework and assumptions. It also shows that modern finance paradigms have been seriously mis-interpreted, mis-modeled, mis-tested, and mis-applied in many occasions, including those causing recent CAPM controversies. In its Mathematical Appendix, GCAPM provides first-hand, closed-form derivations of modern finance paradigms, a new set of asset pricing theorems, and various forms of capital asset pricing models from the perspective of competitive capital market equilibrium. It reveals the competitive equilibrium model behind Ross and Roll's APT (1976) for the first time since 1976. It also proposes a new Canonical Capital Asset Pricing Model, which supports for Sharpe's (1988-95) return-based style analyses and enhances CAPM's two asset-pricing portfolios into a set of market-driven canonical asset-pricing portfolios. GCAPM resolves CAPM controversies, unifies positive and normative thoughts of finance, establishes missing links between modern finance paradigms and real-world financial practices, and provides a new framework for financial studies.