Monotonicity in Asset Returns: New Tests with Applications to the Term Structure, the CAPM and Portfolio Sorts

Many theories in …nance imply monotonic patterns in expected returns and other …nancial variables: The liquidity preference hypothesis predicts higher expected returns for bonds with longer times to maturity; the CAPM implies higher expected returns for stocks with higher betas; and standard asset pricing models imply that the pricing kernel is declining in market returns. The full set of implications of monotonicity is generally not exploited in empirical work, however. This paper proposes new and simple ways to test for monotonicity in …nancial variables and compares the proposed tests with extant alternatives such as t-tests, Bonferroni bounds and multivariate inequality tests through empirical applications and simulations.