Linear-Betas in the Cross-Section of Returns

Abstract

This paper evaluates a specification for conditional beta models following Fama and French (2019). In this paper, I reject the Fama and French model that assumes characteristics are conditional betas in favor of a linear conditional beta model following Shanken (1990). Model-implied zero-beta rates are particularly sensitive to the specification, and the linear conditional beta model provides a significantly lower rate. Out-of-sample tests show that the Linear-Beta Model has a significantly lower bias and Clark and West (2007) adjusted MSPE, but it may come at the cost of a larger variance than the Fama and French model.

Keywords: Fama-MacBeth, Cross-Section, Time-Varying Beta, Linear-Beta Model

JEL Classification: G10, G12, G19