Thin-Trading Effects in Beta: Bias v. Estimation Error
FEB at KU Leuven
Martina L. Vandebroek
Katholieke Universiteit Leuven - Faculty of Business and Economics
City University of Hong Kong (CityUHK) - Department of Economics & Finance
Two regression coefficients often used in Finance, the Scholes-Williams (1977) quasi-multiperiod thin-trading beta and the Hansen-Hodrick (1980) overlapping-periods regression coefficient, can both be written as instrumental-variables estimators. Competitors are Dimson's beta and the Hansen-Hodrick original OLS beta. We check the performance of all these estimators and the validity of the t-tests in small and medium samples, in and outside their stated assumptions, and we report their performances in a hedge-fund style portfolio-management application. In all experiments as well as in the real-data estimates, less bias comes at the cost of a higher standard error. Our hedge-portfolio experiment shows that the safest procedure even is to simply match by size and industry; any estimation just adds noise. There is a clear relation between portfolio variance and the variance of the beta estimator used in market-neutralizing the portfolio, dwarfing the beneficial effect of bias.
Number of Pages in PDF File: 25
Keywords: Market Model, Thin Trading
JEL Classification: C13, C22, G11
Date posted: March 1, 2007
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