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Learning about beta: time-varying factor loadings, expected returns, and the conditional CAPM

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Tobias Adrian
Francesco Franzoni

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Abstract

We complement the conditional capital asset pricing model (CAPM) by introducing unobservable long-run changes in risk factor loadings. In this environment, investors rationally “learn” the long-run level of factor loading by observing realized returns. As a direct consequence of this assumption, conditional betas are modeled using the Kalman filter. 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 ratio, our learning-augmented conditional CAPM fails to be rejected. ; Original title: Learning about beta: a new look at CAPM tests.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 193.

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Date of creation: 2008
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Handle: RePEc:fip:fednsr:193

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Keywords: Capital assets pricing model ; Investments;

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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. Peter C.B. Phillips & Donggyu Sul, 2007. "Transition Modeling and Econometric Convergence Tests," Cowles Foundation Discussion Papers 1595, Cowles Foundation, Yale University. [Downloadable!]
    Other versions:
  2. 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". [Downloadable!]
  3. Chris Brooks & Xiafei Li & Joelle Miffre, 2007. "The Value Premium and Time-Varying Unsystematic Risk," ICMA Centre Discussion Papers in Finance icma-dp2007-03, Henley Business School, Reading University. [Downloadable!]
  4. Andrew Ang & Joseph chen, 2005. "CAPM Over the Long Run: 1926-2001," NBER Working Papers 11903, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. 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. [Downloadable!] (restricted)
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