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Heteroskedasticity In Stock Returns

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  • SCHWERT, G.W.
  • SEGUIN, P.J.

Abstract

The authors use predictions of aggregate stock return variances from daily data to estimate time-varying monthly variances for size-ranked portfolios. The authors propose and estimate a single factor model of heteroskedasticity for portfolio returns. This model implies time-varying betas. Implications of heteroskedasticity and time-varying betas for tests of the capital asset pricing model are then documented. Accounting for heteroskedasticity increases the evidence that risk-adjusted returns are related to firm size. The authors also estimate a constant correlation model. Portfolio volatilities predicted by this model are similar to those predicated by more complex multivariate generalized autoregressive conditional heteroskedasticity procedures. Copyright 1990 by American Finance Association.

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Bibliographic Info

Paper provided by Rochester, Business - General in its series Papers with number bc_88-02.

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Length: 17 pages
Date of creation: 1988
Date of revision:
Handle: RePEc:fth:robuge:bc_88-02

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Postal: UNIVERSITY OF ROCHESTER, CENTER FOR MANUFACTURING AND OPERATIONS MANAGEMENT, WILLIAM E. SIMON GRADUATE SCHOOL OF BUSINESS ADMINISTRATION,
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Web page: http://www.simon.rochester.edu/
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Related research

Keywords: homoskedasticity ; efficiency ; portfolios;

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References

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  1. Murphy, Kevin M & Topel, Robert H, 1985. "Estimation and Inference in Two-Step Econometric Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 3(4), pages 370-79, October.
  2. G. William Schwert, 1990. "Stock Volatility and the Crash of '87," NBER Working Papers 2954, National Bureau of Economic Research, Inc.
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  4. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
  5. Scholes, Myron & Williams, Joseph, 1977. "Estimating betas from nonsynchronous data," Journal of Financial Economics, Elsevier, vol. 5(3), pages 309-327, December.
  6. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-47, February.
  7. Skinner, Douglas J., 1989. "Options markets and stock return volatility," Journal of Financial Economics, Elsevier, vol. 23(1), pages 61-78, June.
  8. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  9. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
  10. Donald B. Keim & Robert F. Stambaugh, . "Predicting Returns in the Stock and Bond Markets," Rodney L. White Center for Financial Research Working Papers 15-85, Wharton School Rodney L. White Center for Financial Research.
  11. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  12. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-53, December.
  13. Pagan, A.R. & Schwert, G.W., 1989. "Alternative Models For Conditional Stock Volatility," Papers 89-02, Rochester, Business - General.
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  15. Bey, Roger P. & Pinches, George E., 1980. "Additional Evidence of Heteroscedasticity in the Market Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(02), pages 299-322, June.
  16. Barone-Adesi, Giovanni & Talwar, Prem P, 1983. "Market Models and Heteroscedasticity of Residual Security Returns," Journal of Business & Economic Statistics, American Statistical Association, vol. 1(2), pages 163-68, April.
  17. J. A. Hausman, 1976. "Specification Tests in Econometrics," Working papers 185, Massachusetts Institute of Technology (MIT), Department of Economics.
  18. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, vol. 22(1), pages 27-59, October.
  19. Martin, John D & Klemkosky, Robert C, 1975. "Evidence of Heteroscedasticity in the Market Model," The Journal of Business, University of Chicago Press, vol. 48(1), pages 81-86, January.
  20. Chan, K C & Chen, Nai-Fu, 1988. " An Unconditional Asset-Pricing Test and the Role of Firm Size as an Instrumental Variable for Risk," Journal of Finance, American Finance Association, vol. 43(2), pages 309-25, June.
  21. Giaccotto, Carmelo & Ali, Mukhtar M, 1982. " Optimum Distribution-Free Tests and Further Evidence of Heteroscedasticity in the Market Model," Journal of Finance, American Finance Association, vol. 37(5), pages 1247-57, December.
  22. Johnson, Herb & Shanno, David, 1987. "Option Pricing when the Variance Is Changing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 143-151, June.
  23. Ohlson, James A. & Penman, Stephen H., 1985. "Volatility increases subsequent to stock splits: An empirical aberration," Journal of Financial Economics, Elsevier, vol. 14(2), pages 251-266, June.
  24. Baillie, Richard T. & Bollerslev, Tim, 1990. "A multivariate generalized ARCH approach to modeling risk premia in forward foreign exchange rate markets," Journal of International Money and Finance, Elsevier, vol. 9(3), pages 309-324, September.
  25. Kraus, Alan & Litzenberger, Robert H, 1976. "Skewness Preference and the Valuation of Risk Assets," Journal of Finance, American Finance Association, vol. 31(4), pages 1085-1100, September.
  26. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
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