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Most empirical studies of the static CAPM assume that betas remain constant over time and that the return on the value-weighted portfolio of all stocks is a proxy for the return on aggregate wealth. The general consensus is that the static CAPM is unable to explain satisfactorily the cross-section of average returns on stocks. We assume that the CAPM holds in a conditional sense, i.e., betas and the market risk premium vary over time. We include the return on human capital when measuring the return on aggregate wealth. Our specification performs well in explaining the cross-section of average returns.A SUBSTANTIAL PART OF the research effort in finance is directed toward improving our understanding of how investors value risky cash flows. It is generally agreed that investors demand a higher expected return for investment in riskier projects, or securities. However, we still do not fully understand how investors assess the risk of the cash flow on a project and how they determine what risk premium to demand. Several capital asset-pricing models have been suggested in the literature that describe how investors assess risk and value risky cash flows. Among them, the Sharpe-Lintner-Black Capital Asset Pricing Model (CAPM)1 is the one that financial managers use most often for assessing the risk of the cash flow from a project and for arriving at the appropriate * Jagannathan is from thebaugh, as well as with participants at numerous finance workshops in the United States, Canada, and East Asia. Special thanks go to the anonymous referee and the managing editor of the journal for valuable comments. We are grateful to Eugene Fama for providing us with the Fama-French factors and Raymond A. Dragan for editorial assistance. All errors in this paper are the authors' responsibility. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Ravi Jagannathan gratefully acknowledges financial support from the National Science Foundation (grant SBR-9409824). Zhenyu Wang gratefully acknowledges financial support from the Alfred P. Sloan Foundation (doctoral dissertation fellowship, grant DD-518). An earlier version of the paper appeared under the title, "The CAPM Is Alive and Well." The compressed archive of the data and the FORTRAN programs used for this paper can be obtained via anonymous FTP at ftp.socsci.umn.edu. The path is outgoing/wang/capm.tar.Z. 1 See Sharpe (1964), Lintner (1965), and Black (1972). 3 4The Journal of Finance discount rate to use in valuing the project. According to the CAPM, (a) the risk of a project is measured by the beta of the cash flow with respect to the return on the market portfolio of all assets in the economy, and (b) the relation between required expected return and beta is linear. Over the past two decades a number of studies have empirically examined the performance of the static version of the CAPM in explaining the crosssection of realized average returns. The results reported in these studies ...

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