Abstract
Recent asset pricing research claims that models generate dynamic risks related to firm investment policy and provide a rational explanation for size and value effects. We examine the empirical success of these dynamic beta models using both simulations and data from U.S. equity markets. Our simulation analysis shows that estimating dynamic betas is challenging even when the true model is known. In actual data we find little evidence that theories of real growth options explain standard pricing anomalies or conditional pricing puzzles such as SEO underperformance. Stock returns do not have the proper conditional covariances with the market portfolio, even though firm characteristics do behave in accordance with the real options models.
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