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Activity Number: 344
Type: Contributed
Date/Time: Tuesday, July 31, 2012 : 10:30 AM to 12:20 PM
Sponsor: Business and Economic Statistics Section
Abstract - #305239
Title: Time-Varying Beta and the Value Premium: Evidence from the Varying-Coefficient Single-Index Model
Author(s): Chaojiang Wu*+ and Hui Guo and Yan Yu
Companies: University of Cincinnati and University of Cincinnati and University of Cincinnati
Address: Department of Operations, Business Analytics, and Information Systems, Cincinnati, OH, , US
Keywords: Conditional CAPM ; Penalized Splines ; Single-Index Models ; Value Premium ; Variables Selection ; Time-Varying Beta

We investigate whether the conditional CAPM helps explain the value premium using the varying-coefficient single-index model. Our empirical specification has two novel advantages relative to those commonly used in the previous studies. First, it allows for a nonlinear dependence of conditional beta on state variables. Second, from a large set of candidate state variables, we identify the most influential ones through an exhaustive variable selection method. Consistent with the notion that the value premium tends to be riskier during business recessions than during business expansions, we find that its conditional beta comoves with unemployment and inflation, the two most closely watched gauges of aggregate economy by the Federal Reserve, and the price-earnings ratio. Unemployment remains a significant explanatory variable when we include the realized beta as a state variable. The alpha is smaller for the conditional CAPM than for the unconditional CAPM; nevertheless, neither model fully explains the value premium.

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