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Heteroskedasticity In Stock Returns

  • SCHWERT, G.W.
  • SEGUIN, P.J.

We use predictions of aggregate stock return variances from daily data to estimate time varying monthly variances for size-ranked portfolios. We propose and estimate a single factor model of heteroskedasticity for portfolio returns. This model implies time-varying betas. Implications of heteroskedasticity and time-varying betas for tests of the capital asset pricing model (CAPM) are then documented. Accounting for heteroskedasticity increases the evidence that risk-adjusted returns are related to firm size. We also estimate a constant correlation model. Portfolio volatilities predicted by this model are similar to those predicted by more complex multivariate generalized-autoregressive- conditional- heteroskedasticity (GARCH) procedures.

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Paper provided by Rochester, Business - General in its series Papers with number bc_88-02.

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Length: 17 pages
Date of creation: 1988
Date of revision:
Handle: RePEc:fth:robuge:bc_88-02
Contact details of provider: Postal: UNIVERSITY OF ROCHESTER, CENTER FOR MANUFACTURING AND OPERATIONS MANAGEMENT, WILLIAM E. SIMON GRADUATE SCHOOL OF BUSINESS ADMINISTRATION,
Web page: http://www.simon.rochester.edu/
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  1. G. William Schwert, 1990. "Why Does Stock Market Volatility Change Over Time?," NBER Working Papers 2798, National Bureau of Economic Research, Inc.
  2. Schwert, G.W., 1989. "Stock Volatility And The Crash Of '87," Papers 89-01, Rochester, Business - General.
  3. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  4. Pagan, Adrian R. & Schwert, G. William, 1990. "Alternative models for conditional stock volatility," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 267-290.
  5. Giaccotto, Carmelo & Ali, Mukhtar M, 1982. " Optimum Distribution-Free Tests and Further Evidence of Heteroscedasticity in the Market Model," Journal of Finance, American Finance Association, vol. 37(5), pages 1247-57, December.
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  7. 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, 09.
  8. Donald B. Keim & Robert F. Stambaugh, . "Predicting Returns in the Stock and Bond Markets," Rodney L. White Center for Financial Research Working Papers 15-85, Wharton School Rodney L. White Center for Financial Research.
  9. Martin, John D & Klemkosky, Robert C, 1975. "Evidence of Heteroscedasticity in the Market Model," The Journal of Business, University of Chicago Press, vol. 48(1), pages 81-86, January.
  10. Hausman, Jerry A, 1978. "Specification Tests in Econometrics," Econometrica, Econometric Society, vol. 46(6), pages 1251-71, November.
  11. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  12. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  13. Wiggins, James B., 1987. "Option values under stochastic volatility: Theory and empirical estimates," Journal of Financial Economics, Elsevier, vol. 19(2), pages 351-372, December.
  14. Murphy, Kevin M & Topel, Robert H, 1985. "Estimation and Inference in Two-Step Econometric Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 3(4), pages 370-79, October.
  15. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
  16. Scholes, Myron & Williams, Joseph, 1977. "Estimating betas from nonsynchronous data," Journal of Financial Economics, Elsevier, vol. 5(3), pages 309-327, December.
  17. Chan, K C & Chen, Nai-Fu, 1988. " An Unconditional Asset-Pricing Test and the Role of Firm Size as an Instrumental Variable for Risk," Journal of Finance, American Finance Association, vol. 43(2), pages 309-25, June.
  18. Ohlson, James A. & Penman, Stephen H., 1985. "Volatility increases subsequent to stock splits: An empirical aberration," Journal of Financial Economics, Elsevier, vol. 14(2), pages 251-266, June.
  19. Gibbons, Michael R. & Shanken, Jay, 1987. "Subperiod aggregation and the power of multivariate tests of portfolio efficiency," Journal of Financial Economics, Elsevier, vol. 19(2), pages 389-394, December.
  20. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
  21. Baillie, Richard T. & Bollerslev, Tim, 1990. "A multivariate generalized ARCH approach to modeling risk premia in forward foreign exchange rate markets," Journal of International Money and Finance, Elsevier, vol. 9(3), pages 309-324, September.
  22. Barone-Adesi, Giovanni & Talwar, Prem P, 1983. "Market Models and Heteroscedasticity of Residual Security Returns," Journal of Business & Economic Statistics, American Statistical Association, vol. 1(2), pages 163-68, April.
  23. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
  24. Kraus, Alan & Litzenberger, Robert H, 1976. "Skewness Preference and the Valuation of Risk Assets," Journal of Finance, American Finance Association, vol. 31(4), pages 1085-1100, September.
  25. Johnson, Herb & Shanno, David, 1987. "Option Pricing when the Variance Is Changing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(02), pages 143-151, June.
  26. Skinner, Douglas J., 1989. "Options markets and stock return volatility," Journal of Financial Economics, Elsevier, vol. 23(1), pages 61-78, June.
  27. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  28. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-47, February.
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