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Learning about Beta: Time-Varying Factor Loadings, Expected Returns,and the Conditional CAPM

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Author Info

  • Francesco FRANZONI

    (University of Lugano and Swiss Finance Institute)

  • Tobias ADRIAN

    (Federal Reserve Bank of New York)

Abstract

We complement the conditional CAPM by introducing unobservable long-run changes in risk factor loadings. In this environment, investors rationally `learn' the long-level of factor loadings from the observation of realized returns. As a direct consequence of this assumption, conditional betas are modeled using the Kalman ¯lter. Because of its focus on low frequency variation in betas, our approach circumvents recent criticisms of the conditional CAPM. When tested on portfolios sorted by size and book-to-market, our learning-augmented conditional CAPM fails to be rejected.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-36.

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Length: 51 pages
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Handle: RePEc:chf:rpseri:rp0836

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Web page: http://www.SwissFinanceInstitute.ch
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Keywords: Asset Pricing; Bayesian Learning; CAPM Anomalies; Value Premium;

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References

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Cited by:
  1. Arnaud Mehl, 2013. "Large global volatility shocks, equity markets and globalisation: 1885-2011," Globalization and Monetary Policy Institute Working Paper 148, Federal Reserve Bank of Dallas.
  2. Lu, Jin-Ray & Lee, Pei-Hsuan & Chuang, I-Yuan, 2011. "Estimation of oil firm's systematic risk via composite time-varying models," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 81(11), pages 2389-2399.
  3. Bruno Giovannetti & Mauro Rodrigues, Eduardo Ros, 2014. "Investment Grade, Asset Prices and Changes in the Source of Systematic Risk," Working Papers, Department of Economics 2014_05, University of São Paulo (FEA-USP).
  4. Michel Fliess & Cédric Join, 2013. "Systematic and multifactor risk models revisited," Post-Print hal-00920175, HAL.
  5. Ang, Andrew & Chen, Joseph, 2007. "CAPM over the long run: 1926-2001," Journal of Empirical Finance, Elsevier, vol. 14(1), pages 1-40, January.
  6. Peter C. B. Phillips & Donggyu Sul, 2007. "Transition Modeling and Econometric Convergence Tests," Econometrica, Econometric Society, vol. 75(6), pages 1771-1855, November.
  7. Todd, Prono, 2009. "Market Proxies, Correlation, and Relative Mean-Variance Efficiency: Still Living with the Roll Critique," MPRA Paper 20031, University Library of Munich, Germany.
  8. Wallmeier, Martin & Tauscher, Kathrin, 2012. "A Note on the Impact of Portfolio Overlapping in Tests of the Fama and French Three-Factor Model," FSES Working Papers 433, Faculty of Economics and Social Sciences, University of Freiburg/Fribourg Switzerland.
  9. Riccardo Ferretti & Francesco Pattarin, 2008. "Is public information really public? The role of newspapers," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 08013, Universita di Modena e Reggio Emilia, Facoltà di Economia "Marco Biagi".
  10. Carmine Trecroci, 2012. "Uncertainty and the Dynamics of Multifactor Loadings and Pricing Errors," Economics Bulletin, AccessEcon, vol. 32(3), pages 2453-2463.
  11. Carl Chiarella & Roberto Dieci & Xue-Zhong He, 2010. "Time-Varying Beta: A Boundedly Rational Equilibrium Approach," Research Paper Series 275, Quantitative Finance Research Centre, University of Technology, Sydney.
  12. Zhi Da & Re-Jin Guo & Ravi Jagannathan, 2009. "CAPM for Estimating the Cost of Equity Capital: Interpreting the Empirical Evidence," NBER Working Papers 14889, National Bureau of Economic Research, Inc.
  13. He, Zhongzhi (Lawrence) & Kryzanowski, Lawrence, 2008. "Dynamic betas for Canadian sector portfolios," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 1110-1122, December.
  14. Michel Fliess & C\'edric Join, 2013. "Systematic and multifactor risk models revisited," Papers 1312.5271, arXiv.org.
  15. Fernando D. Chague, 2013. "Conditional Betas and Investor Uncertainty," Working Papers, Department of Economics 2013_04, University of São Paulo (FEA-USP).

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