Time-Varying Beta and the Value Premium: A Single-Index Varying-Coefficient Model Approach

48 Pages Posted: 6 Mar 2015

See all articles by Hui Guo

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Chaojiang Wu

Drexel University

Yan Yu

University of Cincinnati - Department of Business Analytics

Date Written: March 1, 2015

Abstract

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

Keywords: Conditional CAPM, Penalized Splines, Single-Index Models, Value Premium, Variable Selection

Suggested Citation

Guo, Hui and Wu, Chaojiang and Yu, Yan, Time-Varying Beta and the Value Premium: A Single-Index Varying-Coefficient Model Approach (March 1, 2015). Available at SSRN: https://ssrn.com/abstract=2574080 or http://dx.doi.org/10.2139/ssrn.2574080

Hui Guo (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business
418 Carl H. Lindner Hall
Cincinnati, OH 45221
United States
513.556.7077 (Phone)
513.556.0979 (Fax)

HOME PAGE: http://homepages.uc.edu/~guohu/

Chaojiang Wu

Drexel University ( email )

3141 Chestnut St
Philadelphia, PA 19104
United States

Yan Yu

University of Cincinnati - Department of Business Analytics ( email )

606 Carl H. Lindner Hall 2925 Campus Green Drive
PO Box 210211
Cincinnati, OH 45221-0211
United States

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