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Bayesian Analysis of Stochastic Betas

Published online by Cambridge University Press:  06 April 2009

Gergana Jostova  and
Alexander Philipov
Gergana Jostova
Affiliation:
jostova@gwu.edu, George Washington University, Department of Finance, 2023 G St, Washington, DC 20052
Alexander Philipov
Affiliation:
philipov@american.edu, American University, Kogod School of Business, Department of Finance, 4400 Massachusetts Ave, Washington, DC 20016.
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Abstract

We propose a mean-reverting stochastic process for the market beta. In a simulation study, the proposed model generates significantly more precise beta estimates than GARCH betas, betas conditioned on aggregate or firm-level variables, and rolling regression betas, even when the true betas are generated based on these competing specifications. Our model significantly improves out-of-sample hedging effectiveness. In asset pricing tests, our model provides substantially stronger support for the conditional CAPM relative to competing beta models and helps resolve asset pricing anomalies such as the size, book-to-market, and idiosyncratic volatility effects in the cross section of stock returns.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 40 , Issue 4 , December 2005 , pp. 747 - 778
Copyright
Copyright © School of Business Administration, University of Washington 2005

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