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We propose a framework of risk premium that offers a resolution to CAPM's challenge to the field of strategy. Our core assumption is that investors bear firm-specific risk because they are not as diversified and markets not as perfect as CAPM assumes. We therefore hypothesize that investors require lower risk premiums from firms that are able to reduce firm-specific risk, and we ground this prediction on theories from information economics, risk management, and strategy, as well as recent empirical challenges to CAPM.
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Chatterjee et al. (1999) studied this question.
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