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Time-varying betas and the cross-sectional return-risk relation: evidence from the UK

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  • Patricia Fraser
  • Foort Hamelink
  • Martin Hoesli
  • Bryan Macgregor

Abstract

The seminal study by Fama and MacBeth in 1973 initiated a stream of papers testing for the cross-sectional relation between return and risk. The debate as to whether beta is a valid measure of risk was reanimated by Fama and French and subsequent studies. Rather than focusing on exogenous variables that have a larger explanatory power than an asset's beta in cross-sectional tests, the matrix of variances-covariances is assumed to follow a time varying ARCH process. Using monthly data from the UK market from February 1975 to December 1996, the cross-sectional return-risk relations obtained with an unconditional specification for assets' betas are compared to those obtained when the estimated betas are based on an ARCH model. The approach taken by Pettengill, Sundaram and Mathur, which allows a negative cross sectional return-risk relation in periods in which the market portfolio yields a negative return relative to the risk free rate, was also investigated. These tests are also carried out on samples pertaining to a specific month and on samples from which a particular month is removed. Results suggest that the CAPM holds better in downward moving markets than in upward moving markets hence beta is a more appropriate measure of risk in bear markets.

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  • Patricia Fraser & Foort Hamelink & Martin Hoesli & Bryan Macgregor, 2004. "Time-varying betas and the cross-sectional return-risk relation: evidence from the UK," The European Journal of Finance, Taylor & Francis Journals, vol. 10(4), pages 255-276.
    • Handle: RePEc:taf:eurjfi:v:10:y:2004:i:4:p:255-276
    DOI: 10.1080/13518470110053407
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    Cited by:

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    3. Joliet, Robert & Hubner, Georges, 2008. "Corporate international diversification and the cost of equity: European evidence," Journal of International Money and Finance, Elsevier, vol. 27(1), pages 102-123, February.
    4. Valadkhani, Abbas, 2022. "Do large-cap exchange-traded funds perform better than their small-cap counterparts in extreme market conditions?☆," Global Finance Journal, Elsevier, vol. 53(C).
    5. Muhammad Hanif & Abdullah Iqbal & Zulfiqar Shah, 2016. "Risk and Returns of Sharīʿah Compliant Stocks on the Karachi Stock Exchange – A CAPM and SCAPM Approach المخاطر والعوائد في مقطع عرضي من الأسهم المتوافقة مع الشريعة: اختبار متانة التطبيق وعيوب نموذج ت," Journal of King Abdulaziz University: Islamic Economics, King Abdulaziz University, Islamic Economics Institute., vol. 29(2), pages 37-54, January.
    6. Don U.A. Galagedera & Roland G. Shami, 2004. "Beta Risk and Regime Shift in Market Volatility," Econometric Society 2004 Australasian Meetings 126, Econometric Society.
    7. Dr. Ibrahim Onour, "undated". "The Global Financial Crisis and Equity Markets in Middle East Oil Exporting Countries," API-Working Paper Series 1009, Arab Planning Institute - Kuwait, Information Center.
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    10. Guermat, Cherif & Freeman, Mark C., 2010. "A net beta test of asset pricing models," International Review of Financial Analysis, Elsevier, vol. 19(1), pages 1-9, January.

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    More about this item

    Keywords

    CAPM; QTARCH; return-risk relation; UK market;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General

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