Conditional Beta Pricing Models: A Nonparametric Approach

47 Pages Posted: 15 May 2011 Last revised: 4 Jul 2011

See all articles by Eva Ferreira

Eva Ferreira

Universidad del País Vasco (UPV/EHU) - Department of Applied Economics III (Econometrics and Statistics)

Javier Gil-Bazo

Universitat Pompeu Fabra; Barcelona Graduate School of Economics (Barcelona GSE)

Susan Orbe

affiliation not provided to SSRN

Date Written: May 2011

Abstract

We propose a two-stage procedure to estimate conditional beta pricing models that allows for flexibility in the dynamics of asset betas and market prices of risk (MPR). First, conditional betas are estimated nonparametrically for each asset and period using the time-series of previous data. Then, time-varying MPR are estimated from the cross-section of returns and betas. We prove the consistency and asymptotic normality of the estimators. We also perform Monte Carlo simulations for the conditional version of the three-factor model of Fama and French (1993) and show that nonparametrically estimated betas outperform rolling betas under different specifications of beta dynamics. Using return data on the 25 size and book-to-market sorted portfolios, we find that the nonparametric procedure produces a better fit of the three-factor model to the data, less biased estimates of MPR and lower pricing errors than the Fama-MacBeth procedure with betas estimated under several alternative parametric specifications.

Keywords: Kernel estimation, Conditional asset pricing models, Fama-French three-factor model, Locally stationary processes

JEL Classification: G12, C14, C32

Suggested Citation

Ferreira Garcia, Eva and Gil-Bazo, Javier and Orbe, Susan, Conditional Beta Pricing Models: A Nonparametric Approach (May 2011). Available at SSRN: https://ssrn.com/abstract=1838375 or http://dx.doi.org/10.2139/ssrn.1838375

Eva Ferreira Garcia

Universidad del País Vasco (UPV/EHU) - Department of Applied Economics III (Econometrics and Statistics) ( email )

Avda. Lehendakari Aguirre 83
Bilbao, Vizcaya 48015
Spain
+34 94 601 3739 (Phone)
+34 94 601 3754 (Fax)

Javier Gil-Bazo (Contact Author)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Susan Orbe

affiliation not provided to SSRN

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