Essays on Empirical Asset Pricing

Abstract

This dissertation studies the economic interpretation and empirical implications of the zero-beta rate in asset pricing models. In linear factor models, the zero-beta rate is defined as the expected return on a portfolio with zero exposure to all priced systematic risk factors. Although closely related to the risk-free rate in theory, empirical research typically proxies the zero-beta rate using Treasury bill yields without directly estimating it from asset pricing restrictions. This dissertation asks three main questions: What does the data imply about the zero-beta rate across a wide range of factor models? How should the high empirical estimates of the zero-beta rate be interpreted? And what are the implications of zero-beta portfolios for measuring the risk-free rate, testing and comparing asset pricing models, and constructing investment strategies?To answer these questions, the dissertation proceeds in four chapters.Chapter 2 documents and characterizes the zero-beta rate across a broad class of asset pricing models. Using portfolio-based and cross-sectional regression approaches, the chapter estimates the zero-beta rate and evaluates its stability in- and out-of-sample. The key finding is that the estimated zero-beta rate is persistently high—typically around 10–12 percent per year—and remarkably robust across model specifications. This empirical regularity constitutes the zero-beta rate puzzle.Chapter 3 provides a theoretical and quantitative resolution of this puzzle by linking the zero-beta rate to factor model misspecification. Using mean-variance geometry, analytical derivations, and simulation analysis, the chapter shows that when a factor model is strongly misspecified, pricing errors mechanically distort the estimated zero-beta rate. In such settings, the zero-beta rates converge to the mean return of the global minimum-variance portfolio. The central conclusion is that the high zero-beta rate reflects model incompleteness rather than the true intertemporal risk-free rate.Chapter 4 turns to bounding the frictionless risk-free rate directly. Combining no-arbitrage restrictions with forward-looking measures of expected market returns and lower bounds on the market risk premium, the chapter derives economically meaningful upper bounds on the unobserved risk-free rate. The results indicate that the frictionless risk-free rate is substantially lower than the factor model-implied zero-beta rate. This evidence further reinforces that the zero-beta rate should not be interpreted as the true risk-free rate.Chapter 5 develops practical applications of zero-beta portfolios for model testing, comparison, and investment. The chapter constructs zero-investment zero-beta portfolios to design diagnostic tests of model validity and formal procedures for comparing competing factor models. It also evaluates factor-neutral investment strategies under realistic transaction costs. The findings show that zero-beta portfolio properties provide informative measures of model performance and that factor-neutral strategies are economically meaningful because they are more resilient to trading costs than conventional factor-investing approaches. Overall, the dissertation clarifies the economic meaning of the zero-beta rate, resolves the zero-beta rate puzzle through the lens of factor model misspecification, and demonstrates how zero-beta portfolios can be used to evaluate asset pricing models and design implementable investment strategies.