MODELING THE RISK AND RETURN RELATION CONDITIONAL ON MARKET VOLATILITY AND MARKET CONDITIONS

Don Galagedera and Robert Faff

International Journal of Theoretical and Applied Finance (IJTAF), 2005, vol. 08, issue 01, 75-95

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; modeling conditional betas (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (5)

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Working Paper: Modelling the Risk and Return Relation Conditional on Market Volatility and Market Conditions (2004)
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DOI: 10.1142/S0219024905002901

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