Simpler Better Market Betas

Abstract

This paper proposes a robust one-pass estimator that is easy to code: Justified by the market-model itself and using a prior that market-betas should not be less than --2 and more than +4, the market-model is run on daily stock rates of return that have first been winsorized at --2 and +4 times the contemporaneous market rate of return. The resulting estimates outperform all other known estimators in predicting the future OLS market-beta (on R^2 metrics). Adding reasonable age decay, suggesting a half-life of about 3 to 5 months, to observations entering the market-model further improves it. The estimates outpredict the Vasicek estimates by about half as much as the Vasicek estimates outpredict the OLS estimates.

Keywords: market-beta, robust estimation, winsorization

JEL Classification: G1, G12