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Two Market Forces in Asset Prices

This paper utilizes Black's (1972) zero-beta CAPM to derive an alternative form dubbed the ZCAPM. The ZCAPM posits that asset prices are a function of market risk composed of two components: average market returns and cross-sectional market volatility. Market risk associated with average market returns in the CAPM market model is known as beta risk. We refer to market risk related to cross-sectional market volatility as zeta risk. Using U.S. stock returns from January 1965 to December 2015, out-of-sample cross-sectional asset pricing tests show that both market forces in the ZCAPM are significantly priced. For example, using beta-zeta sorted portfolios, the market prices of beta and zeta risks have t-values of 11.2 and 23.1, respectively, which far exceed the significance of any previous cross-sectional tests of various factors in asset pricing models. These and other empirical tests lead us to conclude that the ZCAPM represents a major breakthrough in asset pricing models.