Monash University

Capital Asset Pricing Model, Bear, Usual and Bull Market Conditions and Beta Instability: A Value-At-Risk Approach

Email address: Param.Silvapulle@BusEco.Monash.edu.au

Keywords: Large Returns, Value-at-Risk, Quantile Estimation, Threshold Model, Beta-Instability

JEL Classifications: G10, C12 and C14

Abstract:
It has long been investigated in the finance literature that whether or not beta responds asymmetrically to good and bad news as measured by positive and negative returns respectively. In this paper we define three market scenarios, namely, bad, usual and good, conditional on the quantiles of the market returns distribution. We investigate the asymmetric response of beta to these market conditions by modeling the mean and the volatility of CAPM as nonlinear threshold models with three regimes. We use daily returns on 30 Dow Jones Industrial Stocks for the period January 1991 to December 1999, and S&P 500 returns as a proxy for the market portfolio in this study. We find that for 21 stocks, beta is higher when the market is bearish than that when the market is bullish, while for other 9 stocks the reverse is true. However, the Dow Jones portfolio betas corresponding to poor, usual and good market conditions were found to be 1.071, 1.030, and 1.023 respectively, while ignoring the asymmetric effects, the portfolio beta was 1.032. The results are in accordance with the widely held view that the portfolio beta increases (decreases) when the market is bearish (bullish). Further, estimates of risk premiums in the cross-sectional beta-return relationship indicate that the risk premium is positive and highly significant for the usual-market-beta, while those corresponding to extreme market conditions are negative and statistically insignificant. The strength of the relationship appears to be improved compared to that of a single factor beta-return model. These findings, we believe, have implications for portfolio diversification, performance measurement and risk management, among others.

PDF file of paper: silvapulle.pdf

Session: Asset Prices I

Time: Saturday, 7 July, 2:15pm - 3:45pm

Room: E