56 Pages Posted: 25 Mar 2008 Last revised: 27 Jan 2013
Date Written: January 21, 2009
This paper examines the pricing implications of time-variation in assets' market betas over the business cycle in a conditional CAPM framework. We use a half century of real GDP growth expectations from economists' surveys to determine forecasted economic states. This approach largely avoids the confounding effects of econometric forecasting model error. The expectation measure forecasts the market return controlling for existing predictive variables. The loadings on the expectation measure explain a significant fraction of cross-sectional variation in stock returns. A fully tradable, ex ante mimicking portfolio generates positive risk-adjusted returns during good economic times over four decades.
Keywords: conditional CAPM, beta-instability risk, value and growth betas, time-varying premium, business cycle, Livingston Survey, investor expectations
JEL Classification: G12
Suggested Citation: Suggested Citation
Goetzmann, William N. and Watanabe, Akiko and Watanabe, Masahiro, Investor Expectations, Business Conditions, and the Pricing of Beta-Instability Risk (January 21, 2009). AFA 2009 San Francisco Meetings Paper; EFA 2007 Ljubljana Meetings Paper; Yale ICF Working Paper. Available at SSRN: https://ssrn.com/abstract=1108711 or http://dx.doi.org/10.2139/ssrn.1108711