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Modeling The Risk And Return Relation Conditional On Market Volatility And Market Conditions

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Author Info
DON U. A. GALAGEDERA () (Department of Econometrics and Business Statistics, Monash University, PO Box 197, Caulfield East, Victoria 3145, Australia)
ROBERT FAFF () (Department of Accounting and Finance, Monash University, Clayton, VIC 3800, Australia)

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Abstract

This paper investigates whether the risk-return relation varies, depending on changing market volatility and up/down market conditions. Three market regimes based on the level of conditional volatility of market returns are specified — "low", "neutral" and "high". The market model is extended to allow for these three market regimes and a three-beta asset-pricing model is developed. For a set of US industry sector indices using a cross-sectional regression, we find that the beta risk premium in the three market volatility regimes is priced. These significant results are uncovered only in the pricing model that accommodates up/down market conditions.

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Publisher Info
Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

Volume (Year): 08 (2005)
Issue (Month): 01 ()
Pages: 75-95
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Handle: RePEc:wsi:ijtafx:v:08:y:2005:i:01:p:75-95

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Related research
Keywords: CAPM; conditional market volatility; modeling conditional betas;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Engle, Robert F & Ng, Victor K, 1993. " Measuring and Testing the Impact of News on Volatility," Journal of Finance, American Finance Association, vol. 48(5), pages 1749-78, December. [Downloadable!] (restricted)
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  2. Pettengill, Glenn N. & Sundaram, Sridhar & Mathur, Ike, 1995. "The Conditional Relation between Beta and Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(01), pages 101-116, March. [Downloadable!]
  3. Brooks, Robert D. & Faff, Robert W. & Yew, Kee Ho, 1997. "A new test of the relationship between regulatory change in financial markets and the stability of beta risk of depository institutions," Journal of Banking & Finance, Elsevier, vol. 21(2), pages 197-219, February. [Downloadable!] (restricted)
  4. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March. [Downloadable!] (restricted)
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  5. Bhardwaj, Ravinder K & Brooks, LeRoy D, 1993. "Dual Betas from Bull and Bear Markets: Reversal of the Size Effect," Journal of Financial Research, Southern Finance Association and Southwestern Finance Association, vol. 16(4), pages 269-83, Winter.
  6. Bos, T & Newbold, P, 1984. "An Empirical Investigation of the Possibility of Stochastic Systematic Risk in the Market Model," Journal of Business, University of Chicago Press, vol. 57(1), pages 35-41, January. [Downloadable!] (restricted)
  7. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March. [Downloadable!] (restricted)
  8. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April. [Downloadable!] (restricted)
  9. Kim, Moon K. & Zumwalt, J. Kenton, 1979. "An Analysis of Risk in Bull and Bear Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 14(05), pages 1015-1025, December. [Downloadable!]
  10. Faff, Robert, 2001. "A Multivariate Test of a Dual-Beta CAPM: Australian Evidence," The Financial Review, Eastern Finance Association, vol. 36(4), pages 157-74, November.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Don U.A. Galagedera, 2004. "A survey on risk-return analysis," Finance 0406010, EconWPA. [Downloadable!]
  2. Don U.A. Galagedera & Roland G. Shami, 2004. "Beta Risk and Regime Shift in Market Volatility," Econometric Society 2004 Australasian Meetings 126, Econometric Society. [Downloadable!]
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