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Conditional Betas

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  • Tano Santos
  • Pietro Veronesi
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    Abstract

    Empirical evidence shows that conditional market betas vary substantially over time. Yet, little is known about the source of this variation, either theoretically or empirically. Within a general equilibrium model with multiple assets and a time varying aggregate equity premium, we show that conditional betas depend on (a) the level of the aggregate premium itself; (b) the level of the firm's expected dividend growth; and (c) the firm's fundamental risk, that is, the one pertaining to the covariation of the firm's cash-flows with the aggregate economy. Especially when fundamental risk (c) is strong, the model predicts that market betas should display a large time variation, that their cross-sectional dispersion should be negatively related to the aggregate premium, and that investments in physical capital should be positively related to changes in betas. These predictions find considerable support in the data.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10413.

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    Date of creation: Apr 2004
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    Handle: RePEc:nbr:nberwo:10413

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    Cited by:
    1. Adrian, Tobias & Franzoni, Francesco, 2009. "Learning about beta: Time-varying factor loadings, expected returns, and the conditional CAPM," Journal of Empirical Finance, Elsevier, Elsevier, vol. 16(4), pages 537-556, September.
    2. Jessica Wachter & Martin Lettau, 2005. "Why is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium," 2005 Meeting Papers, Society for Economic Dynamics 302, Society for Economic Dynamics.
    3. Tano Santos & Pietro Veronesi, 2005. "Cash-Flow Risk, Discount Risk, and the Value Premium," NBER Working Papers 11816, National Bureau of Economic Research, Inc.
    4. L. Baele & K. Inghelbrecht, 2006. "Structural versus Temporary Drivers of Country and Industry Risk," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium, Ghent University, Faculty of Economics and Business Administration 06/413, Ghent University, Faculty of Economics and Business Administration.
    5. Carmine Trecroci, 2012. "Uncertainty and the Dynamics of Multifactor Loadings and Pricing Errors," Economics Bulletin, AccessEcon, vol. 32(3), pages 2453-2463.
    6. Baele, Lieven & Inghelbrecht, Koen, 2009. "Time-varying Integration and International diversification strategies," Journal of Empirical Finance, Elsevier, Elsevier, vol. 16(3), pages 368-387, June.
    7. Cosemans, M. & Frehen, R.G.P. & Schotman, P.C. & Bauer, R.M.M.J., 2009. "Efficient Estimation of Firm-Specific Betas and its Benefits for Asset Pricing Tests and Portfolio Choice," MPRA Paper 23557, University Library of Munich, Germany.
    8. Ang, Andrew & Chen, Joseph, 2007. "CAPM over the long run: 1926-2001," Journal of Empirical Finance, Elsevier, Elsevier, vol. 14(1), pages 1-40, January.
    9. Baele, Lieven & Londono, Juan M., 2013. "Understanding industry betas," Journal of Empirical Finance, Elsevier, Elsevier, vol. 22(C), pages 30-51.
    10. Ammann, Manuel & Kind, Axel & Seiz, Ralf, 2010. "What drives the performance of convertible-bond funds?," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(11), pages 2600-2613, November.
    11. Mariano M. Croce & Martin Lettau & Sydney C. Ludvigson, 2007. "Investor Information, Long-Run Risk, and the Term Structure of Equity," NBER Working Papers 12912, National Bureau of Economic Research, Inc.
    12. Londono Yarce, J.M., 2011. "Essays on asset pricing," Open Access publications from Tilburg University, Tilburg University urn:nbn:nl:ui:12-5146522, Tilburg University.
    13. Fernando D. Chague, 2013. "Conditional Betas and Investor Uncertainty," Working Papers, Department of Economics, University of São Paulo (FEA-USP) 2013_04, University of São Paulo (FEA-USP).

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