Modelling the Risk and Return Relation Conditional on Market Volatility and Market Conditions

Don (Tissa) U. A. Galagedera and Robert William Faff

No 8/04, Monash Econometrics and Business Statistics Working Papers from Monash University, Department of Econometrics and Business Statistics

Abstract: This paper investigates whether the risk-return relation varies, depending on changing market volatility and up/down market conditions. Three market regimes based on the level of conditional volatility of market returns are specified - 'low', 'neutral' and 'high'. The market model is extended to allow for these three market regimes and a three-beta asset-pricing model is developed. For a set of US industry sector indices using a cross-sectional regression, we find that the beta risk premium in the three market volatility regimes is priced. These significant results are uncovered only in the pricing model that accommodates up/down market conditions.

Keywords: CAPM; conditional market volatility; modelling conditional betas (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-fmk
Date: 2004-04
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Related works:
Journal Article: MODELING THE RISK AND RETURN RELATION CONDITIONAL ON MARKET VOLATILITY AND MARKET CONDITIONS (2005)
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