Volume 6, Issue 4

Although there is a consensus about time variation in market betas, it is not clear how this variation should be captured. Several researchers continue to analyze different versions of the conditional CAPM. However, Ghysels (1998) shows that these conditional CAPM models fail to capture the dynamics of beta risk. In this study, we introduce a new model, threshold CAPM, which outperforms both the conditional and unconditional CAPMs by generating smaller pricing errors. We also show that the beta risk changes through time with the changes in the economic environment and the dynamics of time variation of beta differ across industries. These findings have important implications for asset allocation, portfolio selection, and hedging decisions.

Using asymmetric nonlinear smooth-transition GARCH(M) models for the period of 1926:01 - 1997:12, this paper shows that monthly excess returns on value-weighted market indexes exhibit a strong asymmetric reverting pattern; a negative return reverts more quickly, with a greater reverting magnitude, to positive returns, than do positive returns revert to negative returns. This paper also reveals that the relationship between future volatility and its risk premium is surprisingly negative when a negative return shock has been realized. The observed asymmetry in return dynamics is directly associated with a reduction in risk premium following a negative return shock. The reduction in risk premium causes not only the current stock price to rise but also the realized negative return to revert faster.

In a recent paper, Razzak (2001) finds some evidence of two types of asymmetry,steepness and deepness, in international business cycle data, using the nonparametric test of Randles et al. (1980). In this paper, we test for three types of asymmetry: steepness, deepness and sharpness, using the new parametric tests of Clements and Krolzig (2003), in the real GDP of six countries, corresponding to four major economies (U.S., U.K., Japan and Germany) and two small open economies increasingly cited in the literature, Australia and New Zealand. Comparing the Triples test results, corrected for autocorrelation, to Clements and Krolzig's methodology, parametric tests provide stronger evidence of international business cycle asymmetries.