Augmenting the Intertemporal CAPM with Inflation: Further Evidence from Alternative Models
Posted: 2 Jun 2020
Date Written: May 23, 2017
Studies consistently find that inflation is an important augmented factor for intertemporal capital asset pricing models (ICAPMs) when pricing the Fama–French 25 size and book-to-market portfolios. We extend this line of research by investigating two alternative ICAPM models (from Michel; Hahn and Lee) and the three-factor model from Hou et al. We find significant evidence that both ICAPMs and Hou et al.’s three-factor model perform better when augmented with inflation than the original models. The augmented models achieve a good model fit with the fewest factors, thus avoiding or alleviating the over-fitting problem.
Keywords: Asset pricing, ICAPM, inflation, over-fitting problem
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