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Efficient Estimation of Firm-Specific Betas and its Benefits for Asset Pricing Tests and Portfolio Choice

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  • Cosemans, M.
  • Frehen, R.G.P.
  • Schotman, P.C.
  • Bauer, R.M.M.J.

Abstract

We improve both the specification and estimation of firm-specific betas. Time variation in betas is modeled by combining a parametric specification based on economic theory with a non-parametric approach based on data-driven filters. We increase the precision of individual beta estimates by setting up a hierarchical Bayesian panel data model that imposes a common structure on parameters. We show that these accurate beta estimates lead to a large increase in the cross-sectional explanatory power of the conditional CAPM. Using the betas to forecast the covariance matrix of returns also results in a significant improvement in the out-of-sample performance of minimum variance portfolios.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23557.

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Date of creation: 22 Jun 2009
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Handle: RePEc:pra:mprapa:23557

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Related research

Keywords: asset pricing; portfolio choice; time-varying betas; Bayesian econometrics; panel data;

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References

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Cited by:
  1. Da, Zhi & Guo, Re-Jin & Jagannathan, Ravi, 2012. "CAPM for estimating the cost of equity capital: Interpreting the empirical evidence," Journal of Financial Economics, Elsevier, vol. 103(1), pages 204-220.
  2. Jacquier, Eric & Titman, Sheridan & YalçIn, Atakan, 2010. "Predicting systematic risk: Implications from growth options," Journal of Empirical Finance, Elsevier, vol. 17(5), pages 991-1005, December.

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