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A conditional CAPM; implications for the estimation of systematic risk

  • Alexandros E. Milionis

    ()

    (Bank of Greece)

  • Dimitra K. Patsouri

    (University of Athens)

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    The purpose of this paper is to examine: (i) whether or not, the residuals of the Market Model are conditionally heteroscedastic; (ii) whether or not, there exists an intervalling effect in conditional heteroscedasticity in the residuals of the Market Model; (iii) the effect of conditional heteroscedasticity on the estimation of systematic risk.; as well as to propose a simple data driven conditional CAPM. To this end daily closing price of stocks traded at the Athens Stock Exchange are used. Empirical evidence is provided for the existence of: (a) conditional heteroscedasticity in MM residuals; (b) a pronounced intervalling effect on ARCH in MM residuals; (c) GARCH in mean type of conditional heteroscedasticity for the majority of cases where ARCH was present in MM residuals. These findings in terms of theory are conducive to a conditional CAPM, which takes into account the effect of conditional variance on expected returns, rather than the standard CAPM. Furthermore, in terms of practical implications these findings may lead to better estimates of systematic risk.

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    File URL: http://www.bankofgreece.gr/BogEkdoseis/Paper2011131.pdf
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    Paper provided by Bank of Greece in its series Working Papers with number 131.

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    Length: 19
    Date of creation: May 2011
    Date of revision:
    Handle: RePEc:bog:wpaper:131
    Contact details of provider: Web page: http://www.bankofgreece.gr

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    1. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    2. Kalman J. Cohen & Gabriel A. Hawawini & Steven F. Maier & Robert A. Schwartz & David K. Whitcomb, 1983. "Estimating and Adjusting for the Intervalling-Effect Bias in Beta," Management Science, INFORMS, vol. 29(1), pages 135-148, January.
    3. Cohen, Kalman J. & Hawawini, Gabriel A. & Maier, Steven F. & Schwartz, Robert A. & Whitcomb, David K., 1983. "Friction in the trading process and the estimation of systematic risk," Journal of Financial Economics, Elsevier, vol. 12(2), pages 263-278, August.
    4. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
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