Beta is Still Useful

48 Pages Posted: 15 Mar 2012

See all articles by Yexiao Xu

Yexiao Xu

University of Texas at Dallas - School of Management

Yihua Zhao

Tulane University - A.B. Freeman School of Business

Date Written: March 15, 2012

Abstract

This paper investigates whether beta can predict the expected return after controlling for the beta instability resulting from shift in the covariance structure. Such a shift is primarily due to noise investors chasing stocks with high idiosyncratic volatility. Consequently, these stocks tend to have low future returns from overpricing, and high beta because noise investors can also move the market at the same time. Indeed, we see that the beta estimate of the current period is positively related to the beta estimate and negatively related to the idiosyncratic volatility measure of the last period. More important, different from existing studies, we find that beta estimates of the current period can significantly explain the cross-sectional differences in future returns of individual stocks, when allowing for an interaction between the current idiosyncratic volatility and the beta estimates. We also show that our simple model can predict the historical expected return well. All results are robust with respect to different measures of beta and idiosyncratic volatility and subsample.

Keywords: Expected Return, Idiosyncratic Volatility, Misspricing, Time-varying Beta

JEL Classification: G12

Suggested Citation

Xu, Yexiao and Zhao, Yihua, Beta is Still Useful (March 15, 2012). Available at SSRN: https://ssrn.com/abstract=2022818 or http://dx.doi.org/10.2139/ssrn.2022818

Yexiao Xu (Contact Author)

University of Texas at Dallas - School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States
972-883-6703 (Phone)

HOME PAGE: http://www.utdallas.edu/~yexiaoxu

Yihua Zhao

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

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