CAPM Beta Is a Proxy, Not a Market Cause

If you hedge a stock against the market, you may be blocking the wrong thing. The paper argues that the familiar CAPM beta, which many traders read as “market moves cause stock moves,” does not fit realized equity returns cleanly. The problem is the “aggregator contradiction”: the market return is built from the same stocks it is supposed to explain, unless it is lagged or measured with the stock left out. To sort that out, the author treats CAPM as a structural causal model, a map of cause-and-effect links. In the most plausible setup, an external driver Z pushes both the market return and the stock return, so the market is a proxy rather than a mechanism. In that reading, ordinary least squares beta is an attenuated signal of how well the market captures Z. The paper also shows that “beta-neutral” portfolios can still be exposed to macro or sector shocks, and hedging on the market can import index-specific noise. Using stylized models and large-cap U.S. equity data, the paper finds that contemporaneous betas behave like proxies. Any real market-to-stock effect, if it exists, shows up only with a lag and is economically modest. The practical takeaway is simple: CAPM should be read as associational, not causal.

CAPM, the Capital Asset Pricing Model, is the old market-risk rule of thumb. Beta is the stock's market sensitivity. A market return is built from the stocks inside it. That sounds harmless until you try to hedge. A beta of 1 says a stock tends to move with the market proxy. It does not prove the market pushes the stock. The argument asks a sharper question. What if both move because a third force hits them both? That force can be a sector shock, a macro shock, or some other common driver. A beta-neutral book, a portfolio built to cancel market exposure, can still bleed in the same storm. The surprise is that the familiar CAPM story may describe shared motion, not a push from the index.

The hidden loop inside beta

The market return is a value-weighted basket of its own members. Big firms count more in that basket. So a same-period arrow from the market to one stock points back into the basket that made the market. The argument calls this the aggregator contradiction. To avoid that loop, it treats CAPM as a structural causal model, a diagram of what may cause what. The cleanest story is a fork. One outside driver, called Z, pushes both the market and the stock. In that setup, the usual line fit does not show a market force. It shows how well the market catches Z. Tests on stylized models and large-cap U.S. equity data fit that picture. Contemporaneous betas act like proxies. Any market-to-stock link, if it exists, shows up only at a lag. Its economic size looks modest.

How the causal map works

The method starts with a simple map. That map is a structural causal model, meaning a diagram of what may cause what. It uses three nodes: an outside driver Z, the market return, and one stock return. The model asks which arrows can fit realized returns without contradiction. One arrow says Z moves both returns. Another says the market moves the stock. A third keeps the market link only at a lag or after removing the stock from the market basket. The fork, Z to both, comes out as the most believable baseline. In that setup, beta measures a proxy fit, not a direct push.

Why beta-neutral can still miss the risk

That shift changes portfolio language. A beta-neutral book, a portfolio built to cancel market exposure, can still carry macro risk from the wider economy. It can also carry sector risk. Hedging on the market can import index-specific noise, the quirks of the market basket itself. The market proxy may hide the real driver instead of removing it. That means factor attribution, the bookkeeping that splits returns across named drivers, needs a new habit. Ask which cause stays open. Ask which cause you have actually blocked. In that view, alpha is not magic skill. It is what remains after the named causal paths are shut.

What to test next

The next test is a leave-one-out market return, which leaves the stock out, on large-cap U.S. equity data. That strips the stock out of the market basket before asking about cause. It gives the cleanest check on the aggregator contradiction. If the lagged link still survives, it looks more like a delayed move. If it fades, the market proxy was doing most of the work. Either way, the old one-number reading of beta looks too simple. Beta is often a stand-in for a shared force, not a pipe from the index.