An empirical investigation of asset pricing models under divergent lending and borrowing rates

Asset pricing theory implies that the estimate of the zero-beta rate should fall between divergent lending and borrowing rates. This paper proposes a formal test of this restriction using the difference between the prime loan rate and the 1-month Treasury bill rate as a proxy for the difference between borrowing and lending rates. Based on simulations, this paper shows that in the ordinary least squares case, the Fama and MacBeth (J Pol Econ 81:607–636, <CitationRef CitationID="CR7">1973</CitationRef>) t-statistic has high power against a general alternative, which is not true of the Shanken (Rev Financ Stud 5:1–33, <CitationRef CitationID="CR25">1992</CitationRef>) and Kan et al. (J Financ doi:<ExternalRef> <RefSource>10.1111/jofi.12035</RefSource> <RefTarget Address="10.1111/jofi.12035" TargetType="DOI"/> </ExternalRef>, <CitationRef CitationID="CR16">2013</CitationRef>) t-statistics. In the generalized least squares case, all three t-statistics have high power. The empirical investigation highlights that only the intertemporal capital asset pricing model reasonably prices the zero-beta portfolio. Other models, such as the Fama and French (J Financ Econ 33:3–56, <CitationRef CitationID="CR6">1993</CitationRef>) model, do not assign the correct value to the zero-beta rate. Copyright Swiss Society for Financial Market Research 2014