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Association between Markov regime-switching market volatility and beta risk: Evidence from Dow Jones industrial securities

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Author Info
Don U.A. Galagedera (Monash University)
Roland Shami (Monash University)

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Abstract

In this paper, the volatility of the return generating process of the market portfolio and the slope coefficient of the market model is assumed to follow a Markov switching process of order one. The results indicate very strong evidence of volatility switching behaviour in a sample of returns in the S&P500 index. In three of the thirty securities in the Dow Jones index, the estimated slope in the market model show strong switching behaviour. In these three securities the low risk state is more persistent than the high-risk state. For each security we estimate the conditional probabilities that the security is in the high (low) risk state given the market is in the high (low) volatility regime and show that this information can be used to classify securities into three distinct groups. There is no association between these groups and the securities' constant beta estimated in the market model and the Sharpe index. Some directions for further research are discussed.

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Paper provided by EconWPA in its series Finance with number 0406011.

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Length: 27 pages
Date of creation: 23 Jun 2004
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Handle: RePEc:wpa:wuwpfi:0406011

Note: Type of Document - pdf; pages: 27
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Web page: http://129.3.20.41

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Related research
Keywords: Asset pricing; Markov regime-switching; market volatility; beta risk;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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  2. R.W. Faff & R.D. Brooks, 1998. "Time-varying Beta Risk for Australian Industry Portfolios: An Exploratory Analysis," Journal of Business Finance & Accounting, Blackwell Publishing, vol. 25(5&6), pages 721-745. [Downloadable!] (restricted)
  3. repec:bep:sndecm:1:1996:1:35-46 is not listed on IDEAS
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  5. Brooks, R.D. & Faff, R.W. & Lee, J.H.H., 1994. "Beta Stability and Portfolio Formation," Papers 94-3, Melbourne - Centre in Finance.
    Other versions:
  6. Fabozzi, Frank J & Francis, Jack Clark, 1977. "Stability Tests for Alphas and Betas over Bull and Bear Market Conditions," Journal of Finance, American Finance Association, vol. 32(4), pages 1093-99, September. [Downloadable!] (restricted)
  7. Bos, T & Newbold, P, 1984. "An Empirical Investigation of the Possibility of Stochastic Systematic Risk in the Market Model," Journal of Business, University of Chicago Press, vol. 57(1), pages 35-41, January. [Downloadable!] (restricted)
  8. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 307-333. [Downloadable!] (restricted)
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  9. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April. [Downloadable!] (restricted)
  10. repec:bla:jbfnac:v:25:y:1998:i:5&6:p:721-745 is not listed on IDEAS
  11. G. William Schwert, 1990. "Business Cycles, Financial Crises, and Stock Volatility," NBER Working Papers 2957, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Goodwin, Thomas H, 1993. "Business-Cycle Analysis with a Markov-Switching Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(3), pages 331-39, July.
  13. William F. Sharpe, 1965. "Mutual Fund Performance," Journal of Business, University of Chicago Press, vol. 39, pages 119. [Downloadable!]
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