Smooth Transition Quantile Capital Asset Pricing Models with Heteroscedasticity

Computational Economics, Forthcoming

38 Pages Posted: 2 May 2011

See all articles by Cathy W. S. Chen

Cathy W. S. Chen

Feng Chia University - Department of Statistics; Graduate Institute of Statistics & Actuarial Science, Feng Chia University

Simon Lin

Feng Chia University - Graduate Institute of Statistics & Actuarial Science

Philip L. H. Yu

The University of Hong Kong - Department of Statistics & Actuarial Science

Date Written: January 6, 2011

Abstract

Capital asset pricing model (CAPM) has become a fundamental tool in finance for assessing the cost of capital, risk management, portfolio diversification and other financial assets. It is generally believed that the market risks of the assets, often denoted by a beta coefficient, should change over time. In this paper, we model time-varying market betas in CAPM by a smooth transition regime switching CAPM with heteroscedasticity, which provides flexible nonlinear representation of market betas as well as flexible asymmetry and clustering in volatility. We also employ the quantile regression to investigate the nonlinear behavior in the market betas and volatility under various market conditions represented by different quantile levels. Parameter estimation is done by a Bayesian approach. Finally, we analyze some Dow Jones Industrial stocks to demonstrate our proposed models. The model selection method shows that the proposed smooth transition quantile CAPM-GARCH model is strongly preferred over a sharp threshold transition and a symmetric CAPM-GARCH model.

Keywords: Bayesian Inference, CAPM, GARCH, Quantile Regression, Skewed-Laplace Distribution, Smooth Transition

JEL Classification: C11, C22, C51, C52.

Suggested Citation

Chen, Cathy W. S. and Lin, Simon and Yu, Philip L. H., Smooth Transition Quantile Capital Asset Pricing Models with Heteroscedasticity (January 6, 2011). Computational Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1810743 or http://dx.doi.org/10.2139/ssrn.1810743

Cathy W. S. Chen (Contact Author)

Feng Chia University - Department of Statistics ( email )

100 Wen Hwa Road
Taichung, 407
Taiwan
886 4 24517250 ext 4412 (Phone)
886 4 24517092 (Fax)

HOME PAGE: http://myweb.fcu.edu.tw/~chenws/

Graduate Institute of Statistics & Actuarial Science, Feng Chia University

100 Wenhwa Road
Talchung
Taiwan
886 4-24517250 ext 4412 (Phone)
886 4-2517092 (Fax)

HOME PAGE: http://myweb.fcu.edu.tw/~chenws/

Simon Lin

Feng Chia University - Graduate Institute of Statistics & Actuarial Science ( email )

100 Wen Hwa Road
Taichung, 407
Taiwan

Philip L. H. Yu

The University of Hong Kong - Department of Statistics & Actuarial Science ( email )

Hong Kong
Hong Kong

HOME PAGE: http://web.hku.hk/~plhyu

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