This paper uses a multivariate GARCH model to account for time variation in factor loadings and idiosyncratic risk in improving the performance of the CAPM and the three-factor Fama--French model. I show how to incorporate time variation in betas and the second moments of the residuals in a very general way. Both the static and conditional CAPM substantially outperform the three-factor model in pricing industry portfolios. Using a dynamic CAPM model results in a 30% reduction in the average absolute pricing error of size/book-to-market portfolios. Ad hoc analysis shows that the market beta of a value-minus-growth portfolio decreases whenever the default premium increases as well as during economic recessions. Copyright The Author 2009. Published by Oxford University Press. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.
{"title":"A Dynamic Asset Pricing Model with Time-Varying Factor and Idiosyncratic Risk","authors":"Paskalis Glabadanidis","doi":"10.1093/JJFINEC/NBP006","DOIUrl":"https://doi.org/10.1093/JJFINEC/NBP006","url":null,"abstract":"This paper uses a multivariate GARCH model to account for time variation in factor loadings and idiosyncratic risk in improving the performance of the CAPM and the three-factor Fama--French model. I show how to incorporate time variation in betas and the second moments of the residuals in a very general way. Both the static and conditional CAPM substantially outperform the three-factor model in pricing industry portfolios. Using a dynamic CAPM model results in a 30% reduction in the average absolute pricing error of size/book-to-market portfolios. Ad hoc analysis shows that the market beta of a value-minus-growth portfolio decreases whenever the default premium increases as well as during economic recessions. Copyright The Author 2009. Published by Oxford University Press. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.","PeriodicalId":114577,"journal":{"name":"OUP: Journal of Financial Econometrics","volume":"39 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2009-04-13","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129749203","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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