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Time-Varying Betas of German Stock Returns

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  • Markus Ebner

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  • Thorsten Neumann

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    Abstract

    The market model assumes stock returns to be a linear function of the market return. However, there is considerable evidence that the beta stability assumption commonly used when estimating the market model is invalid. In this paper we account for beta instability in German stock returns by allowing the coefficients to vary over time in estimation. For time-varying beta estimation we rely on the Flexible Least Squares approach, the Random Walk Model and Moving Window Least Squares. Due to our results time-varying estimation fits the data considerably better than time-invariant estimation and, hence, increases the efficiency of beta based risk measurement. Copyright Swiss Society for Financial Market Research 2005

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    File URL: http://hdl.handle.net/10.1007/s11408-005-2296-5
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    Bibliographic Info

    Article provided by Springer in its journal Financial Markets and Portfolio Management.

    Volume (Year): 19 (2005)
    Issue (Month): 1 (June)
    Pages: 29-46

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    Handle: RePEc:kap:fmktpm:v:19:y:2005:i:1:p:29-46

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    Web page: http://www.springerlink.com/link.asp?id=119763

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    1. Fabozzi, Frank J. & Francis, Jack Clark, 1978. "Beta as a Random Coefficient," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(01), pages 101-116, March.
    2. Alexander, Gordon J. & Benson, P. George & Eger, Carol E., 1982. "Timing Decisions and the Behavior of Mutual Fund Systematic Risk," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(04), pages 579-602, November.
    3. Tesfatsion, Leigh & Veitch, John M., 1990. "U.S. money demand instability A flexible least squares approach," Journal of Economic Dynamics and Control, Elsevier, vol. 14(1), pages 151-173, February.
    4. Chauveau, T. & Maillet, B., 1998. "Flexible Least Squares Betas: The French Market Case," Papers 1998-03/fi, Caisse des Depots et Consignations - Cahiers de recherche.
    5. Brooks, R.D. & Faff, R.W. & Lee, J.H.H., 1994. "Beta Stability and Portfolio Formation," Papers 94-3, Melbourne - Centre in Finance.
    6. Martin MORYSON, 1994. "Testing for Random Walk Coefficients in a Simple State Space Model," SFB 373 Discussion Papers 1994,21, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    7. G. William Schwert & Paul J. Seguin, 1991. "Heteroskedasticity in Stock Returns," NBER Working Papers 2956, National Bureau of Economic Research, Inc.
    8. Sunder, Shyam, 1980. " Stationarity of Market Risk: Random Coefficients Tests for Individual Stocks," Journal of Finance, American Finance Association, vol. 35(4), pages 883-96, September.
    9. Lutkepohl, Helmut & Herwartz, Helmut, 1996. "Specification of varying coefficient time series models via generalized flexible least squares," Journal of Econometrics, Elsevier, vol. 70(1), pages 261-290, January.
    10. Chow, Gregory C., 1984. "Random and changing coefficient models," Handbook of Econometrics, in: Z. Griliches† & M. D. Intriligator (ed.), Handbook of Econometrics, edition 1, volume 2, chapter 21, pages 1213-1245 Elsevier.
    11. Helmut LÜTKEPOHL & Martin MORYSON & Jürgen WOLTERS, 1994. "Stabilitaetsanalyse der bundesdeutschen Geldnachfrage anhand alternativer Ansaetze zur Modellierung variierender Regressionskoeffizienten," SFB 373 Discussion Papers 1994,1, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
    12. Collins, Daniel W & Ledolter, Johannes & Rayburn, Judy Dawson, 1987. "Some Further Evidence on the Stochastic Properties of Systematic Risk," The Journal of Business, University of Chicago Press, vol. 60(3), pages 425-48, July.
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    Cited by:
    1. Tusell Palmer, Fernando Jorge & Esteban González, María Victoria, 2009. "Predicting Betas: Two new methods," BILTOKI 2009-01, Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística).
    2. Xiaoquan Jiang, 2010. "Return dispersion and expected returns," Financial Markets and Portfolio Management, Springer, vol. 24(2), pages 107-135, June.

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