Accounting for the Accuracy of Beta Estimates in CAPM Tests on Assets with Time-Varying Risks

Posted: 22 Oct 1998

See all articles by Tom Berglund

Tom Berglund

Hanken School of Economics - Department of Economics

Johan Knif

Hanken School of Economics

Abstract

This paper advocates two ways to make more efficient use of available information in reducing the bias of the risk premium estimate in two-pass tests of the CAPM. First, explicit modeling of the time-variability of betas can improve the accuracy of the beta forecasts. Second, the cross-sectional information available can be exploited more efficiently using individual stocks instead of portfolios provided that noisy beta predictions are given a smaller weight than more accurate ones. This paper proposes an adjustment of the cross-sectional regressions of excess returns against betas to give larger weights to more reliable beta forecasts. A significant positive relationship between returns and the beta forecast is obtained when the proposed approach is applied to data from the Helsinki Stock Exchange, while the traditional Fama-MacBeth (1973) approach as such finds no relationship at all.

JEL Classification: G12, G15

Suggested Citation

Berglund, Tom Patrik and Knif, Johan Anders, Accounting for the Accuracy of Beta Estimates in CAPM Tests on Assets with Time-Varying Risks. Available at SSRN: https://ssrn.com/abstract=137338

Tom Patrik Berglund (Contact Author)

Hanken School of Economics - Department of Economics ( email )

PO Box 479
FI-00101 Helsinki
Finland
+358-9-43133 345 (Phone)
+358-9-43133 382 (Fax)

Johan Anders Knif

Hanken School of Economics ( email )

P.O. Box 287
FIN-65101 Vasa
Finland
+358 453556008 (Phone)

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