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Time-Varying Betas Help in Asset Pricing: The Threshold CAPM

Author

Listed:
  • Akdeniz Levent

    () (Bilkent University, Graduate School of Business)

  • Altay-Salih Aslihan

    () (Bilkent University, Graduate School of Business)

  • Caner Mehmet

    () (University of Pittsburgh, Department of Economics)

Abstract

Although there is a consensus about time variation in market betas, it is not clear how this variation should be captured. Several researchers continue to analyze different versions of the conditional CAPM. However, Ghysels (1998) shows that these conditional CAPM models fail to capture the dynamics of beta risk. In this study, we introduce a new model, threshold CAPM, which outperforms both the conditional and unconditional CAPMs by generating smaller pricing errors. We also show that the beta risk changes through time with the changes in the economic environment and the dynamics of time variation of beta differ across industries. These findings have important implications for asset allocation, portfolio selection, and hedging decisions.

Suggested Citation

  • Akdeniz Levent & Altay-Salih Aslihan & Caner Mehmet, 2003. "Time-Varying Betas Help in Asset Pricing: The Threshold CAPM," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 6(4), pages 1-18, March.
  • Handle: RePEc:bpj:sndecm:v:6:y:2003:i:4:n:1
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    References listed on IDEAS

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    Cited by:

    1. Cai, Zongwu & Ren, Yu & Yang, Bingduo, 2015. "A semiparametric conditional capital asset pricing model," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 117-126.
    2. Jean-Pierre Fouque & Adam Tashman, 2012. "Option pricing under a stressed-beta model," Annals of Finance, Springer, vol. 8(2), pages 183-203, May.
    3. Cai, Zongwu, 2007. "Trending time-varying coefficient time series models with serially correlated errors," Journal of Econometrics, Elsevier, vol. 136(1), pages 163-188, January.
    4. Yunmi Kim, 2012. "Autoregressive conditional beta," Economics Bulletin, AccessEcon, vol. 32(2), pages 1489-1494.
    5. Ho-Chuan (River) Huang & Pei-Shan Wu, 2005. "Tests of the CAPM with structural instability and asymmetry," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 1(5), pages 321-327, September.

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