An Exact Bayes Test of Asset Pricing Models with Application to International Markets

Financial economists have derived equilibrium asset pricing models such as the Capital Asset Pricing Model (CAPM) of Sharpe (1964) and Lintner (1965) and the consumption-oriented CAPM of Breeden (1979). Subsequent work (e.g., Black, Jensen, and Scholes 1972; Fama and MacBeth 1973; Breeden, Gibbons, and Litzenberger 1989) examined the empirical performance of unconditional versions of these asset pricing models. The empirical tests met with mixed results. More recent work examined versions of pricing models that incorporate lagged variables such as the dividend yield. Studying conditional models has both theoretical and empirical appeal. Theoretically, Hansen and Richard (1987) show that, even if the unconditional CAPM fails, the conditional CAPM could be perfectly valid. In addition, Campbell (1996) shows that any instrument that forecasts future market returns or labor income