Improving the Market Model: The 4-State Model Alternative

Octave JOKUNG and Jean-Christophe MEYFREDI
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Octave JOKUNG: Edhec Business School
Jean-Christophe MEYFREDI: Edhec Business School

Finance from EconWPA

Abstract: The present paper conducts an empirical study by examining the Market Model and the three versions of the 4-State Model (translated, rotated and un-rotated) in a mean-beta framework. Using daily returns from the CAC 40 Index's assets, we find that the explanatory power of the 4-State Model is greater than the one of the Market Model and this effect is improved by rotation. A reduction in the non-systematic risk is also observed when switching from Market Model to 4-State Models. Surprisingly, the betas are more stable when using any version of the 4- State Model. This could have a strong impact on portfolio diversification and call widely held opinion into question.

Keywords: Market Model; Arch (search for similar items in EconPapers)
JEL-codes: G (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk
Date: 2004-03-30
Note: Type of Document - pdf; pages: 24
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0403006

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