A Capital Asset Pricing Model in the Presence of Market Structural Breaks

• Activity Number: 373
• Type: Contributed
• Date/Time: Tuesday, August 11, 2015 : 10:30 AM to 12:20 PM
• Sponsor: Business and Economic Statistics Section
• Author(s): Su Yang* and Haipeng Xing
• Companies: Mount Sinai High School and SUNY Stony Brook
• Keywords: CAPM ; multiple change-points ; structural breaks ; Bayesian statistics

Abstract

The Capital Asset Pricing Model (CAPM) explains the source of asset returns from the perspective of market performance. The interpretability of CAPM has been discussed and criticized from various perspectives by econometricians and statisticians. In this paper, we investigate the interpretability issue of the CAPM in the presence of market structural breaks. Specifically, we model market structural breaks as unknown multiple change-points, and assume the parameters in the CAPM are piecewise constant while undergo sudden changes during market structual changes. Assuming a conjugate prior for the parameters in the CAPM, we are able to drive explicit recursive Bayes estimates for the CAPM parameters. We then use the proposed model to analyze the performance of several stocks, and show that the interpretability of the CAPM can be improved when the assumption of market structural breaks is incorporated.