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Time-Varying Beta: A Boundedly Rational Equilibrium Approach

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By taking into account conditional expectations and the dependence of the systematic risk of asset returns on micro- and macro-economic factors, the conditional CAPM with time-varying betas displays superiority in explaining the cross-section of returns and anomalies in a number of empirical studies. Most of the literature on time-varying beta is motivated by econometric estimation rather than explicit modelling of the stochastic behaviour of betas through agents' behaviour. Within the mean-variance framework of repeated one-period optimisation, we set up a boundedly rational dynamic equilibrium model of a financial market with heterogeneous agents and obtain an explicit dynamic CAPM relation between the expectede quilibrium returns and time-varying betas. By incorporating the three most popular types of investors, fundamentalists, chartists and noise traders, into the model, we show that, independent of the fundamentals, there is a systematic change in the market portfolio, risk-return relationships, and time varying betas when investors change their behaviour, such as the chartists acting as momentum traders. In particular, we demonstrate the stochastic nature of time-varying betas and show that the commonly used rolling window estimates of time-varying betas may not be consistent with the ex-ante betas implied by the equilibrium model. The results provide a number of insights into an understanding o ftime-varying beta.

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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 275.

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Length: 31
Date of creation: 01 May 2010
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Handle: RePEc:uts:rpaper:275

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Keywords: equilibrium asset prices; CAPM; time-varying betas; heterogeneous expectations;

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Cited by:
  1. Anufriev, Mikhail & Bottazzi, Giulio & Marsili, Matteo & Pin, Paolo, 2012. "Excess covariance and dynamic instability in a multi-asset model," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1142-1161.
  2. Carl Chiarella & Roberto Dieci & Xue-Zhong He & Kai Li, 2013. "An evolutionary CAPM under heterogeneous beliefs," Annals of Finance, Springer, vol. 9(2), pages 185-215, May.
  3. Giulio Bottazzi & Pietro Dindo, 2013. "Evolution and market behavior in economics and finance: introduction to the special issue," Journal of Evolutionary Economics, Springer, vol. 23(3), pages 507-512, July.

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