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Time-Varying Betas and Cross-Sectional Return-Risk Relation: Evidence from the UK

Author

Listed:
  • Fraser, P.
  • Hamelink, F.
  • Hoesli, M.
  • MacGregor, B.

Abstract

The seminal study by Fama and MacBeth (1973) initiated a stream of papers testing for the cross-sectional relation between return and risk. The debate wether beta is a valid measure of risk has been renimated by Fama and French (1992) and subsequent studies. Rather than focusing on exogenous variables that have a larger explanatory power than an asset's beta in cross sectional tests, we assume the matrix of variances-covariances to follow a time varying ARCH process. Using monthly data from the UK market from February 1975 to December 1996, we compare the cross sectional return-risk relations obtained with an unconditional specification for asset's betas to those obtained when the estimated betas are based on an ARCH model. We also investigate the Pettengill, Sundaram and Mathure (1995) approach, 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. These tests are also carried out on samples pertaining to a specific month and on samples from which a particular month is removed. Our result suggest that CAPM holds in downward moving markets than in upward moving markets hence beta is a more appropriate measure of risk in bear markets.

Suggested Citation

  • Fraser, P. & Hamelink, F. & Hoesli, M. & MacGregor, B., 2000. "Time-Varying Betas and Cross-Sectional Return-Risk Relation: Evidence from the UK," Papers 2000.03, Ecole des Hautes Etudes Commerciales, Universite de Geneve-.
  • Handle: RePEc:fth:ehecge:2000.03
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    References listed on IDEAS

    as
    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.
    2. Jegadeesh, Narasimhan, 1992. "Does Market Risk Really Explain the Size Effect?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(03), pages 337-351, September.
    3. Ravi Jagannathan & Ellen R. McGrattan, 1995. "The CAPM debate," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 2-17.
    4. Pettengill, Glenn N. & Sundaram, Sridhar & Mathur, Ike, 1995. "The Conditional Relation between Beta and Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(01), pages 101-116, March.
    5. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-1152, September.
    6. Modigliani, Franco. & Pogue, G. A., 1973. "A test of the capital asset pricing model on European stock markets," Working papers 667-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    7. Affleck-Graves, J. F. & Bradfield, D. J., 1993. "An examination of the power of Univariate tests of the CAPM: A simulation approach," Journal of Economics and Business, Elsevier, vol. 45(1), pages 17-33, February.
    8. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    9. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-455, July.
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    Citations

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    Cited by:

    1. Don U.A. Galagedera, 2004. "A survey on risk-return analysis," Finance 0406010, EconWPA.
    2. Roland Shami & Don U.A. Galagedera, 2004. "Beta Risk and Regime Shift in Market Volatility," Finance 0406012, EconWPA.
    3. 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.

    More about this item

    Keywords

    ECONOMETRICS ; FINANCIAL MARKET;

    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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