CAPM with Option-Implied Betas: Another Rescue Attempt

48 Pages Posted: 14 Feb 2009 Last revised: 18 Mar 2009

See all articles by Adrian Buss

Adrian Buss

INSEAD - Finance; Centre for Economic Policy Research (CEPR)

Christian Schlag

Goethe University Frankfurt - Research Center SAFE

Grigory Vilkov

Frankfurt School of Finance & Management

Date Written: February 14, 2009

Abstract

We test the conditional CAPM with time-varying forward-looking betas, assuming a two-state model for the market risk premium. For market state identification we employ a recursive Markov-switching model based on a forward-looking Sentiment factor. The empirical results for our sample of S&P500 constituents for the period from 1996 to 2007 show that in 'good' states of the economy the classical CAPM with just the market factor is able to explain the cross-section of expected returns very well, while in 'bad' states firm characteristics like size and book-to-market become relevant. Our estimated probabilities for good and bad states are furthermore able to predict the market risk premium one period into the future.

Keywords: conditional CAPM, regime switching, forward-looking betas, sentiment, implied correlations

JEL Classification: G11, G12, G14, G17

Suggested Citation

Buss, Adrian and Schlag, Christian and Vilkov, Grigory, CAPM with Option-Implied Betas: Another Rescue Attempt (February 14, 2009). Available at SSRN: https://ssrn.com/abstract=1342988 or http://dx.doi.org/10.2139/ssrn.1342988

Adrian Buss

INSEAD - Finance ( email )

Boulevard de Constance
Fontainebleau Cedex, 77305
France
+33 160 72 44 84 (Phone)
+33 160 72 40 45 (Fax)

HOME PAGE: http://sites.google.com/view/abuss

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Christian Schlag

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)

Grigory Vilkov (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

HOME PAGE: http://www.vilkov.net

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