Simple Better Market Betas

60 Pages Posted: 6 May 2019

See all articles by Ivo Welch

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Date Written: April 12, 2019

Abstract

The random-effects estimator in Vasicek (1973) and its variants provide the best predictors of market-beta known to date. However, they require multi-pass procedures (time-series and cross-section) and spookily entangle each stock’s beta estimate with unrelated stocks. Yet, the reason for their good performances has been misunderstood. They work so well because they pull in outliers. Thus, a much simpler robust estimator can predict future market-betas at least as well. It only requires first winsorizing stock returns at -1 and +3 times the market rate of return. A quick WLS decay of historical returns improves performance further. Moreover, my paper shows that the Dimson (1979) and Frazzini and Pedersen (2014) estimators are inferior even to plain OLS estimators. They should be considered de-facto inadmissible estimators of market-beta.

Keywords: market-beta, robust estimation, winsorization

JEL Classification: G1,G12

Suggested Citation

Welch, Ivo, Simple Better Market Betas (April 12, 2019). Available at SSRN: https://ssrn.com/abstract=3371240 or http://dx.doi.org/10.2139/ssrn.3371240

Ivo Welch (Contact Author)

University of California, Los Angeles (UCLA) ( email )

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HOME PAGE: http://www.ivo-welch.info

National Bureau of Economic Research (NBER)

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