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We derive a capital asset pricing model with market sentiment from a representative agent that exhibits two basic behavioral biases – ambiguity aversion and positive skewness preference. The asset pricing formula generalizes the classical CAPM by accounting for model uncertainty, positive skewness, disaster risk, and market sentiment, thereby linking four strands of the literature. We apply the Market Sentiment CAPM to provide a unified explanation for the beta anomaly and three other market anomalies, and to predict how they are affected by sentiment. The Market Sentiment CAPM provides a theoretical foundation for the pricing of sentiment in the cross-section of returns.


ESI Working Paper 20-06



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