Pricing Without Mispricing
We test whether a model could price assets if the market were efficient. Specifically, we test whether a model assigns zero alpha to a strategy that uses only decade-old information, which even an inefficient market would correctly price. Persistence in the strategy’s multifactor betas gives our test power. Multifactor betas can help capture mispricing, but persistence in those betas then leads the multifactor model to distort expected returns well after that information gets priced correctly. The CAPM passes our test, but prominent multifactor models do not.
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