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Portfolio Inefficiency and the Cross-Section of Expected Returns

Shmuel Kandel and Robert F. Stambaugh
The Journal of Finance
Vol. 50, No. 1 (Mar., 1995), pp. 157-184
Published by: Wiley for the American Finance Association
DOI: 10.2307/2329242
Stable URL: http://www.jstor.org/stable/2329242
Page Count: 28
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Portfolio Inefficiency and the Cross-Section of Expected Returns
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Abstract

The Capital Asset Pricing Model implies that (i) the market portfolio is efficient and (ii) expected returns are linearly related to betas. Many do not view these implications as separate, since either implies the other, but we demonstrate that either can hold nearly perfectly while the other fails grossly. If the index portfolio is inefficient, then the coefficients and R2 from an ordinary least squares regression of expected returns on betas can equal essentially any values and bear no relation to the index portfolio's mean-variance location. That location does determine the outcome of a mean-beta regression fitted by generalized least squares.

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