Time variation of CAPM betas across market volatility regimes
We investigate time variation in Captial Asset Pricing Model (CAPM) betas for Book-to-Market (B/M) and momentum portfolios across stock market volatility regimes. For our analysis, we jointly model market and portfolio returns using a two-state Markov-switching process, with beta and
the market risk premium allowed to vary between ‘low’ and ‘high’ volatility regimes. Our empirical findings suggest strong evidence of time variation in betas across volatility regimes in almost all the cases for which the unconditional CAPM can be rejected. Although
the regime-switching conditional CAPM can still be rejected in many cases, the time-varying betas help explain portfolio returns much better than the unconditional CAPM, especially when market volatility is high.
Keywords: C32; G12; Markov-switching model; book-to-market; conditional CAPM; momentum
Document Type: Research Article
Affiliations: 1: The Federal Reserve Bank of Richmond, Charlotte Branch, 530 East Trade StreetCharlotteNC 28202, USA 2: School of Economics, Australian School of Business, University of New South Wales, SydneyNSW 2052, Australia
Publication date: 01 October 2011
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