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

Listed author(s):
  • 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)

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.

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File URL: https://www.degruyter.com/view/j/snde.2003.6.4/snde.2003.6.4.1101/snde.2003.6.4.1101.xml?format=INT
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Article provided by De Gruyter in its journal Studies in Nonlinear Dynamics & Econometrics.

Volume (Year): 6 (2003)
Issue (Month): 4 (March)
Pages: 1-18

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Handle: RePEc:bpj:sndecm:v:6:y:2003:i:4:n:1
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  1. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
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  11. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  12. Eric Ghysels, 1998. "On Stable Factor Structures in the Pricing of Risk: Do Time-Varying Betas Help or Hurt?," Journal of Finance, American Finance Association, vol. 53(2), pages 549-573, April.
  13. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
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