Hostname: page-component-8448b6f56d-qsmjn Total loading time: 0 Render date: 2024-04-24T18:20:28.578Z Has data issue: false hasContentIssue false
  • English
  • Français

Time-Varying Beta and the Value Premium

Published online by Cambridge University Press:  29 June 2017

Hui Guo ,
Chaojiang Wu  and
Yan Yu
Get access Rights & Permissions [Opens in a new window]

Abstract

We model conditional market beta and alpha as flexible functions of state variables identified via a formal variable-selection procedure. In the post-1963 sample, the beta of the value premium comoves strongly with unemployment, inflation, and the price–earnings ratio in a countercyclical manner. We also uncover a novel nonlinear dependence of alpha on business conditions: It falls sharply and even becomes negative during severe economic downturns but is positive and flat otherwise. The conditional capital asset pricing model (CAPM) performs better than the unconditional CAPM, but this does not fully explain the value premium. Our findings are consistent with a conditional CAPM with rare disasters.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 4 , August 2017 , pp. 1551 - 1576
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank an anonymous referee, Hendrik Bessembinder (the editor), and Stefan Nagel for helpful comments. Guo acknowledges financial support from the Key Projects of the National Social Science Foundation of China (No. 16ZDA039).

References

Akaike, H.“A New Look at the Statistical Model Identification.” IEEE Transactions on Automatic Control, 19 (1974), 716–723.CrossRefGoogle Scholar
Ang, A., and Chen, J.. “CAPM over the Long Run: 1926–2001.” Journal of Empirical Finance, 14 (2007), 1–40.Google Scholar
Ang, A., and Kristensen, D.. “Testing Conditional Factor Models.” Journal of Financial Economics, 106 (2012), 132–156.Google Scholar
Bai, H.; Hou, K.; Kung, H.; and Zhang, L.. “The CAPM Strikes Back? An Investment Model with Disasters.” Working Paper, Ohio State University (2015).Google Scholar
Bansal, R., and Yaron, A.. “Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles.” Journal of Finance, 59 (2004), 1481–1509.CrossRefGoogle Scholar
Belo, F.; Lin, X.; and Bazdresch, S.. “Labor Hiring, Investment and Stock Return Predictability in the Cross Section.” Journal of Political Economy, 122 (2014), 129–177.Google Scholar
Berger, D.; Dew-Becker, I.; Schmidt, L.; and Takahashi, Y.. “Layoff Risk, the Welfare Cost of Business Cycles, and Monetary Policy.” Working Paper, Northwestern University (2015).CrossRefGoogle Scholar
Boguth, O.; Carlson, M.; Fisher, A.; and Simutin, M.. “Conditional Risk and Performance Evaluation: Volatility Timing, Overconditioning, and New Estimates of Momentum Alphas.” Journal of Financial Economics, 102 (2011), 363–389.Google Scholar
Campbell, J. Y., and Cochrane, J. H.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.Google Scholar
Campbell, J. Y., and Shiller, R. J.. “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies, 1 (1988), 195–228.Google Scholar
Campbell, J. Y., and Vuolteenaho, T.. “Inflation Illusion and Stock Prices.” American Economic Review, 94 (2004), 19–23.Google Scholar
Carroll, R. J.; Fan, J.; Gijbels, I.; and Wand, M. P.. “Generalized Partially Linear Single-Index Models.” Journal of the American Statistical Association, 92 (1997), 477–489.Google Scholar
Carroll, R. J.; Wu, C. J. F.; and Ruppert, D.. “The Effect of Estimating Weights in Weighted Least Squares.” Journal of the American Statistical Association, 83 (1988), 1045–1054.CrossRefGoogle Scholar
Chen, N.-F.; Roll, R.; and Ross, S. A.. “Economic Forces and the Stock Market.” Journal of Business, 59 (1986), 383–403.Google Scholar
Chen, L., and Zhang, L.. “Do Time-Varying Risk Premiums Explain Labor Market Performance?” Journal of Financial Economics, 99 (2011), 385–399.CrossRefGoogle Scholar
Cooper, M., and Gubellini, S.. “The Critical Role of Conditioning Information in Determining If Value Is Really Riskier than Growth.” Journal of Empirical Finance, 18 (2011), 289–305.Google Scholar
Cui, X.; Härdle, W.; and Zhu, L.. “The EFM Approach for Single-Index Models.” Annals of Statistics, 39 (2011), 1658–1688.Google Scholar
Fama, E. F., and French, K. R.. “Business Conditions and Expected Returns on Stocks and Bonds.” Journal of Financial Economics, 25 (1989), 23–49.Google Scholar
Fama, E. F., and French, K. R.. “The Value Premium and the CAPM.” Journal of Finance, 61 (2006), 2163–2185.Google Scholar
Fan, J.; Yao, Q.; and Cai, Z.. “Adaptive Varying-Coefficient Linear Models.” Journal of the Royal Statistical Society, Series B (Statistical Methodology), 65 (2003), 57–80.CrossRefGoogle Scholar
Ferson, W. E., and Harvey, C. R.. “Conditioning Variables and the Cross Section of Stock Returns.” Journal of Finance, 54 (1999), 1325–1360.CrossRefGoogle Scholar
Ghysels, E.“On Stable Factor Structures in the Pricing of Risk: Do Time-Varying Betas Help or Hurt?” Journal of Finance, 53 (1998), 549–573.Google Scholar
Harvey, C.“The Specification of Conditional Expectations.” Journal of Empirical Finance, 8 (2001), 573–638.CrossRefGoogle Scholar
Hastie, T., and Tibshirani, R.. Generalized Additive Models. New York, NY: Chapman and Hall (1990).Google Scholar
Jarrow, R.; Ruppert, D.; and Yu, Y.. “Estimating the Term Structure of Corporate Debt with a Semiparametric Penalized Spline Model.” Journal of the American Statistical Association, 99 (2004), 57–66.Google Scholar
Lettau, M., and Ludvigson, S.. “Resurrecting the (C)CAPM: A Cross-Sectional Test When Risk Premia Are Time-Varying.” Journal of Political Economy, 109 (2001), 1238–1287.Google Scholar
Lewellen, J., and Nagel, S.. “The Conditional CAPM Does Not Explain Asset-Pricing Anomalies.” Journal of Financial Economics, 82 (2006), 289–314.CrossRefGoogle Scholar
Mammen, E.“Bootstrap and Wild Bootstrap for High Dimensional Linear Models.” Annals of Statistics, 21 (1993), 255–285.Google Scholar
Orphanides, A., and Williams, J.. “Robust Monetary Policy Rules with Unknown Natural Rates.” Brookings Papers on Economic Activity, 2 (2002), 63–145.Google Scholar
Paye, B.“‘Deja Vol’: Predictive Regressions for Aggregate Stock Market Volatility Using Macroeconomic Variables.” Journal of Financial Economics, 106 (2012), 527–546.CrossRefGoogle Scholar
Petkova, R., and Zhang, L.. “Is Value Riskier than Growth?” Journal of Financial Economics, 78 (2005), 187–202.CrossRefGoogle Scholar
Petrosky-Nadeau, N.; Zhang, L.; and Kuehn, L.. “Endogenous Economic Disasters and Asset Prices.” Working Paper, Ohio State University (2013).Google Scholar
Ruppert, D.“Selecting the Number of Knots for Penalized Splines.” Journal of Computational and Graphical Statistics, 11 (2002), 735–757.CrossRefGoogle Scholar
Ruppert, D.; Wand, M. P.; and Carroll, R. J.. Semiparametric Regression. New York, NY: Cambridge University Press (2003).CrossRefGoogle Scholar
Schwarz, G.“Estimating the Dimension of a Model.” Annals of Statistics, 6 (1978), 461–464.Google Scholar
Staiger, D.; Stock, J.; and Watson, M.. “How Precise Are Estimates of the Natural Rate of Unemployment?” In Reducing Inflation: Motivation and Strategy, Romer, C. and Romer, D., eds. Chicago, IL: University of Chicago Press (1997).Google Scholar
Stock, J., and Watson, M.. “Forecasting Output and Inflation: The Role of Asset Prices.” Journal of Economic Literature, 41 (2003), 788–829.Google Scholar
Taylor, J.“Discretion versus Policy Rules in Practice.” Carnegie-Rochester Conference Series on Public Policy, 39 (1993), 195–214.CrossRefGoogle Scholar
Wang, K. Q.“Asset Pricing with Conditioning Information: A New Test.” Journal of Finance, 58 (2003), 161–196.Google Scholar
Welch, I., and Goyal, A.. “A Comprehensive Look at the Empirical Performance of Equity Premium Prediction.” Review of Financial Studies, 21 (2008), 1455–1508.Google Scholar
Wu, C. F. J.“Jackknife, Bootstrap and Other Resampling Methods in Regression Analysis (with Discussions).” Annals of Statistics, 14 (1986), 1261–1350.Google Scholar
Wu, T. Z.; Lin, H.; and Yu, Y.. “Single Index Coefficient Models for Nonlinear Time Series.” Journal of Nonparametric Statistics, 23 (2011), 37–58.Google Scholar
Xia, Y., and Li, W. K.. “On Single-Index Coefficient Regression Models.” Journal of the American Statistical Association, 94 (1999), 1275–1285.Google Scholar
Yu, Y., and Ruppert, D.. “Penalized Spline Estimation for Partially Linear Single-Index Models.” Journal of the American Statistical Association, 97 (2002), 1042–1054.Google Scholar
Yu, Y.; Yu, K.; Wang, H.; and Li, M.. “Semiparametric Estimation for a Class of Time-Inhomogeneous Diffusion Processes.” Statistica Sinica, 19 (2009), 843–867.Google Scholar
Zhang, L.“The Value Premium.” Journal of Finance, 60 (2005), 67–103.Google Scholar