This paper is concerned with testing the time series implications of the capital asset pricing model (CAPM) due to Sharpe (1964) and Lintner (1965), when the number of securities, <em>N</em>, is large relative to the time dimension, <em>T</em>, of the return series. Two new tests of CAPM are proposed that exploit recent advances on the analysis of large panel data models, and are valid even if <em>N</em> > <em>T</em>. When the errors are Gaussian and cross sectionally independent, a test, denoted by <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image13.png" width="26" height="15" />, is proposed which is N(0; 1) as <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image10.png" width="68" height="14" />, with <em>T</em> fixed. Even when the errors are non-Gaussian we are still able to show that <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image13.png" width="26" height="15" /> tends to <em>N</em>(0; 1) so long as the errors are cross-sectionally independent and <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image12.png" width="71" height="15" />, with N and T ! 1, jointly. In the case of cross sectionally correlated errors, using a threshold estimator of the average squares of pair-wise error correlations, a modified version of <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image13.png" width="26" height="15" />, denoted by <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image14.png" width="24" height="15" />, is proposed. Small sample properties of the tests are compared using Monte Carlo experiments designed specifically to match the correlations, volatilities, and other distributional features of the residuals of Fama-French three factor regressions of individual securities in the Standard & Poor 500 index. Overall, the proposed tests perform best in terms of power, with empirical sizes very close to the chosen nominal value even in cases where N is much larger than T. The <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image14.png" width="24" height="15" /> test (which allows for non-Gaussian and weakly cross correlated errors) is applied to all securities in the S&P 500 index with 60 months of return data at the end of each month over the period September 1989-September 2011. Statistically significant evidence against Sharpe-Lintner CAPM is found mainly during the recent financial crisis. Furthermore, a strong negative correlation is found between a twelve-month moving average p-values of the <img src="http://www.econ.cam.ac.uk/faculty/pesaran/wp12/image14.png" width="24" height="15" /> test and the returns of long/short equity strategies relative to the return on S&P 500 over the period December 2006 to September 2011, suggesting that abnormal profits are earned during episodes of market inefficiencies.
