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

Author

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  • 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.
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    Cited by:

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    2. Syed ali, Raza & Syed tehseen, jawaid & Imtiaz, arif & Fahim, qazi, 2011. "Validity of capital asset pricing model: evidence from Karachi stock exchange," MPRA Paper 32737, University Library of Munich, Germany.
    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.
    8. Mohammad Abu Sayeed & Mardi Dungey & Wenying Yao, 2018. "High-frequency Characterisation of Indian Banking Stocks," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 17(2_suppl), pages 213-238, August.
    9. Durand, Robert B. & Lan, Yihui & Ng, Andrew, 2011. "Conditional beta: Evidence from Asian emerging markets," Global Finance Journal, Elsevier, vol. 22(2), pages 130-153.
    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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    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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