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Learning about Beta: Time-Varying Factor Loadings, Expected Returns,and the Conditional CAPM

  • Francesco FRANZONI

    (University of Lugano and Swiss Finance Institute)

  • Tobias ADRIAN

    (Federal Reserve Bank of New York)

We complement the conditional CAPM by introducing unobservable long-run changes in risk factor loadings. In this environment, investors rationally `learn' the long-level of factor loadings from the observation of realized returns. As a direct consequence of this assumption, conditional betas are modeled using the Kalman ¯lter. Because of its focus on low frequency variation in betas, our approach circumvents recent criticisms of the conditional CAPM. When tested on portfolios sorted by size and book-to-market, our learning-augmented conditional CAPM fails to be rejected.

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Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-36.

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Length: 51 pages
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Handle: RePEc:chf:rpseri:rp0836
Contact details of provider: Web page: http://www.SwissFinanceInstitute.ch

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