Byline: Hang Bai [firstname.lastname@example.org] (a), Kewei Hou [email@example.com] (b,c), Howard Kung [firstname.lastname@example.org] (d,e), Erica X.N. Li [email@example.com] (f), Lu Zhang [firstname.lastname@example.org] (*,b,g) Keywords CAPM; Rare disasters; Measurement errors; Consumption CAPM; General equilibrium Abstract Embedding disasters into a general equilibrium model with heterogeneous firms induces strong nonlinearity in the pricing kernel, helping explain the empirical failure of the (consumption) CAPM. Our single-factor model reproduces the failure of the CAPM in explaining the value premium in finite samples without disasters and its relative success in samples with disasters. Due to beta measurement errors, the estimated beta-return relation is flat, consistent with the beta "anomaly," even though the true beta-return relation is strongly positive. Finally, the consumption CAPM fails in simulations, even though a nonlinear model with the true pricing kernel holds exactly by construction. Author Affiliation: (a) School of Business, University of Connecticut, 2100 Hillside Road, Storrs, CT 06269, USA (b) Fisher College of Business, Ohio State University, 2100 Neil Avenue, Columbus OH 43210, USA (c) China Academy of Financial Research (CAFR), China (d) London Business School, Regent's Park, Sussex Place, London NW1 4SA, UK (e) The Center for Economic and Policy Research (CEPR), USA (f) Cheung Kong Graduate School of Business, 1 East Chang An Avenue, Oriental Plaza, Beijing 100738, China (g) National Bureau of Economic Research (NBER), USA * Corresponding author at: Fisher College of Business, Ohio State University, 2100 Neil Avenue, Columbus OH 43210, USA. Article History: Received 12 May 2015; Revised 12 February 2018; Accepted 23 February 2018 (footnote)[white star] For helpful comments, we thank our discussants Michael Brennan, Max Croce, and Francisco Gomes, as well as Ron Balvers, Jack Favilukis, Wayne Ferson, Finn Kydland, Ian Martin, Thien Nguyen, Bill Schwert (the editor), Berk Sensoy, Rene Stulz, Selale Tuzel, Mike Weisbach, Ingrid Werner, Chen Xue, and other seminar participants at Federal Reserve Bank of New York, McMaster University, Ohio State University, Peking University, the 2013 Society of Economic Dynamics Annual Meetings, the 2013 University of British Columbia Summer Finance Conference, the 2014 American Economic Association Annual Meetings, the 2014 Econometric Society Winter Meetings, the 2015 University of Southern California Marshall Ph.D. Conference in Finance, and the 2016 Society of Financial Studies Cavalcade. We are particularly indebted to John Cochrane (the referee) for extensive and insightful comments that have improved greatly the quality of our work. This paper supersedes our previous work on "The CAPM strikes back? An investment model with disasters."