Time-Varying Beta: A Boundedly Rational Equilibrium Approach

Carl Chiarella, Roberto Dieci and Xuezhong (Tony) He ()
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Roberto Dieci: Department of Mathematics for Economics and Social Sciences, University of Bologna

No 275, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: By taking into account conditional expectations and the dependence of the systematic risk of asset returns on micro- and macro-economic factors, the conditional CAPM with time-varying betas displays superiority in explaining the cross-section of returns and anomalies in a number of empirical studies. Most of the literature on time-varying beta is motivated by econometric estimation rather than explicit modelling of the stochastic behaviour of betas through agents' behaviour. Within the mean-variance framework of repeated one-period optimisation, we set up a boundedly rational dynamic equilibrium model of a financial market with heterogeneous agents and obtain an explicit dynamic CAPM relation between the expectede quilibrium returns and time-varying betas. By incorporating the three most popular types of investors, fundamentalists, chartists and noise traders, into the model, we show that, independent of the fundamentals, there is a systematic change in the market portfolio, risk-return relationships, and time varying betas when investors change their behaviour, such as the chartists acting as momentum traders. In particular, we demonstrate the stochastic nature of time-varying betas and show that the commonly used rolling window estimates of time-varying betas may not be consistent with the ex-ante betas implied by the equilibrium model. The results provide a number of insights into an understanding of time-varying beta.

Keywords: equilibrium asset prices; CAPM; time-varying betas, heterogeneous expectations (search for similar items in EconPapers)
JEL-codes: D84 G12 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2010-05-01
New Economics Papers: this item is included in nep-cba, nep-fmk and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Published as: Chiarella, C., Dieci, R. and He, X., 2013, "Time-Varying Beta: A Boundedly Rational Equilibrium Approach", Journal of Evolutionary Economics, 23(3), 609-6391.

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Journal Article: Time-varying beta: a boundedly rational equilibrium approach (2013)
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