54 Pages Posted: 16 Jan 2005
Date Written: March 10, 2004
Empirical evidence shows that conditional market betas vary substantially over time. Yet, little is known about the source of this variation, either theoretically or empirically. Within a general equilibrium model with multiple assets and a time varying aggregate equity premium, we show that conditional betas depend on (a) the level of the aggregate premium itself; (b) the level of the firm's expected dividend growth; and (c) the firm's fundamental risk, that is, the one pertaining to the covariation of the firm's cash-flows with the aggregate economy. Especially when fundamental risk (c) is strong, the model predicts that market betas should display a large time variation, that their cross-sectional dispersion should be pro-cyclical, and that investments in physical capital should be positively related to changes in betas. These predictions find considerable support in the data.
Suggested Citation: Suggested Citation
Santos, Tano and Veronesi, Pietro, Conditional Betas (March 10, 2004). AFA 2005 Philadelphia Meetings Paper. Available at SSRN: https://ssrn.com/abstract=649462 or http://dx.doi.org/10.2139/ssrn.649462