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Modelling the Risk and Return Relation Conditional on Market Volatility and Market Conditions

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posted on 03.11.2017, 00:06 by Galagedera, Don U.A., Faff, Robert
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.

History

Year of first publication

2004

Series

Department of Econometrics and Business Statistics

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