Market Beta Dynamics and Portfolio Efficiency

32 Pages Posted: 3 May 2005

See all articles by Eric Ghysels

Eric Ghysels

University of North Carolina Kenan-Flagler Business School; University of North Carolina (UNC) at Chapel Hill - Department of Economics

Eric Jacquier

Boston University School of Management; HEC Montreal - Department of Finance

Date Written: August 2006

Abstract

This paper introduces a new estimation for the dynamics of betas. It combines two previously separate approaches in the literature, data-driven filters and parametric methods. Namely, we show how to estimate the parametric beta dynamics by instrumental variables combined with block-sampling - but not overlapping window filters - of data-driven betas. Instrumental variables are needed because of the measurement errorsin empirical betas. We find that, while betas are very strongly autocorrelated, neither aggregate nor firm-specific variables explain much of their quarterly variation. We then compare block-samplers and overlapping window filters using a criterion of economic significance. Namely, we track the out-of-sample performance of portfolios optimized subject to target beta constraints. For target betas of zero, the case of many hedge funds, we show that estimation error results in systematic overshooting of the target beta. These portfolios benefit from the use of medium to long term estimation windows of daily returns.

Keywords: beta, systematic risk, portfolio efficiency, errors in the variables

JEL Classification: G11, G12, G13, C53, C11, D91

Suggested Citation

Ghysels, Eric and Jacquier, Eric, Market Beta Dynamics and Portfolio Efficiency (August 2006). Available at SSRN: https://ssrn.com/abstract=711942 or http://dx.doi.org/10.2139/ssrn.711942

Eric Ghysels

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Gardner Hall, CB 3305
Chapel Hill, NC 27599
United States
919-966-5325 (Phone)
919-966-4986 (Fax)

HOME PAGE: http://www.unc.edu/~eghysels/

Eric Jacquier (Contact Author)

Boston University School of Management ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, QC H3T 2A7
Canada

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