Efficient Estimation of Firm-Specific Betas and its Benefits for Asset Pricing Tests and Portfolio Choice
P.C. Schotman and
MPRA Paper from University Library of Munich, Germany
We improve both the specification and estimation of firm-specific betas. Time variation in betas is modeled by combining a parametric specification based on economic theory with a non-parametric approach based on data-driven filters. We increase the precision of individual beta estimates by setting up a hierarchical Bayesian panel data model that imposes a common structure on parameters. We show that these accurate beta estimates lead to a large increase in the cross-sectional explanatory power of the conditional CAPM. Using the betas to forecast the covariance matrix of returns also results in a significant improvement in the out-of-sample performance of minimum variance portfolios.
Keywords: asset pricing; portfolio choice; time-varying betas; Bayesian econometrics; panel data (search for similar items in EconPapers)
JEL-codes: G12 C33 C11 (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:23557
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