Hostname: page-component-78c5997874-8bhkd Total loading time: 0 Render date: 2024-11-15T08:24:59.975Z Has data issue: false hasContentIssue false
  • English
  • Français

The Cross Section of Expected Returns with MIDAS Betas

Published online by Cambridge University Press:  06 December 2011

Mariano González ,
Juan Nave  and
Gonzalo Rubio
Mariano González
Affiliation:
Departamento de Economía y Empresa, Universidad CEU Cardenal Herrera, 03203 Elche, Alicante, Spain. mariano.gonzalez@uch.ceu.es, juan.nave@uch.ceu.es
Juan Nave
Affiliation:
Departamento de Economía y Empresa, Universidad CEU Cardenal Herrera, 03203 Elche, Alicante, Spain. mariano.gonzalez@uch.ceu.es, juan.nave@uch.ceu.es
Gonzalo Rubio
Affiliation:
Departamento de Economía y Empresa, Universidad CEU Cardenal Herrera, 46113 Moncada, Valencia, Spain; and Rubio. gonzalo.rubio@uch.ceu.es
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper explores the cross-sectional variation of expected returns for a large cross section of industry and size/book-to-market portfolios. We employ mixed data sampling (MIDAS) to estimate a portfolio’s conditional beta with the market and with alternative risk factors and innovations to well-known macroeconomic variables. The market risk premium is positive and significant, and the result is robust to alternative asset pricing specifications and model misspecification. However, the traditional 2-pass ordinary least squares (OLS) cross-sectional regressions produce an estimate of the market risk premium that is negative, and significantly different from 0. Using alternative procedures, we compare both beta estimators. We conclude that beta estimates under MIDAS present lower mean absolute forecasting errors and generate better out-of-sample performance of the optimized portfolios relative to OLS betas.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 47 , Issue 1 , February 2012 , pp. 115 - 135
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2012

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Ang, A., and Chen, J.. “CAPM over the Long Run: 1926–2001.” Journal of Empirical Finance, 14 (2007), 1–40.CrossRefGoogle Scholar
Ang, A., and Kristensen, D.. “Testing Conditional Factor Models.” Working Paper, Columbia University (2009).CrossRefGoogle Scholar
Bali, T. G. “The Intertemporal Relation between Expected Returns and Risk.” Journal of Financial Economics, 87 (2008), 101–131.CrossRefGoogle Scholar
Brandt, M. W., and Kang, Q.. “On the Relationship between the Conditional Mean and Volatility of Stock Returns: A Latent VAR Approach.” Journal of Financial Economics, 72 (2004), 217–257.CrossRefGoogle Scholar
Brandt, M., and Wang, L.. “Measuring the Time-Varying Risk-Return Relation from the Cross-Section of Equity Returns.” Working Paper, Duke University (2010).Google Scholar
Campbell, J. Y. “Stock Returns and the Term Structure.” Journal of Financial Economics, 18 (1987), 373–399.CrossRefGoogle Scholar
Campbell, J. Y. “Understanding Risk and Return.” Journal of Political Economy, 104 (1996), 298–345.CrossRefGoogle Scholar
Chan, L. K. C.; Karceski, J.; and Lakonishok, J.. “On Portfolio Optimization: Forecasting Covariances and Choosing the Risk Model.” Review of Financial Studies, 12 (1999), 937–974.CrossRefGoogle Scholar
Chang, B.-Y.; Christoffersen, P.; Jacobs, K.; and Vainberg, G.. “Option-Implied Measures of Equity Risk.” Review of Finance, forthcoming (2012).CrossRefGoogle Scholar
Christoffersen, P.; Jacobs, K.; and Vainberg, G.. “Forward-Looking Betas.” Working Paper, McGill University (2008).CrossRefGoogle Scholar
Cochrane, J. H.Asset Pricing, revised ed. Princeton, NJ: Princeton University Press (2005).Google Scholar
DeMiguel, V.; Garlappi, L.; and Uppal, R.. “Optimal versus Naïve Diversification: How Inefficient Is the 1/N Portfolio Strategy?” Review of Financial Studies, 22 (2009), 1915–1953.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Multifactor Explanations of Asset Pricing Anomalies.” Journal of Finance, 51 (1996), 55–84.CrossRefGoogle Scholar
Fama, E. F., and MacBeth, J. D.. “Risk, Return and Equilibrium: Empirical Tests.” Journal of Political Economy, 71 (1973), 607–636.CrossRefGoogle Scholar
Ghysels, E.; Santa-Clara, P.; and Valkanov, R.. “The MIDAS Touch: Mixed Data Sampling Regression Models.” Working Paper, University of California, Los Angeles (2003).Google Scholar
Ghysels, E.; Santa-Clara, P.; and Valkanov, R.. “There Is a Risk-Return Trade-Off After All.” Journal of Financial Economics, 76 (2005), 509–548.CrossRefGoogle Scholar
Ghysels, E.; Santa-Clara, P.; and Valkanov, R.. “Predicting Volatility: Getting the Most Out of Return Data Sampled at Different Frequencies.” Journal of Econometrics, 131 (2006), 59–95.CrossRefGoogle Scholar
Glosten, L. R.; Jagannathan, R.; and Runkle, D. E.. “On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks.” Journal of Finance, 48 (1993), 1779–1801.CrossRefGoogle Scholar
Hahn, J., and Lee, H.. “Yield Spreads as Alternative Risk Factors for Size and Book-to-Market.” Journal of Financial and Quantitative Analysis, 41 (2006), 245–269.CrossRefGoogle Scholar
Hansen, L. P., and Jagannathan, R.. “Assessing Specification Errors in Stochastic Discount Factors Models.” Journal of Finance, 52 (1997), 557–590.CrossRefGoogle Scholar
Jagannathan, R., and Ma, T.. “Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps.” Journal of Finance, 58 (2003), 1651–1683.CrossRefGoogle Scholar
Jagannathan, R., and Wang, Z.. “The Conditional CAPM and the Cross-Section of Expected Returns.” Journal of Finance, 51 (1996), 3–53.Google Scholar
Judge, G. G.; Griffiths, W. E.; Hill, R. C.; Lütkepohl, H.; and Lee, T.-C.. The Theory and Practice of Econometrics, 2nd ed.New York: Wiley (1985).Google Scholar
Kan, R., and Robotti, C.. “Model Comparison Using the Hansen-Jagannathan Distance.” Review of Financial Studies, 22 (2009), 3449–3490.CrossRefGoogle Scholar
Kan, R.; Robotti, C.; and Shanken, J.. “Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology.” Working Paper, Federal Reserve Bank of Atlanta (2009).CrossRefGoogle Scholar
León, A.; Nave, J. M.; and Rubio, G.. “The Relationship between Risk and Expected Return in Europe.” Journal of Banking and Finance, 31 (2007), 495–512.CrossRefGoogle Scholar
Lewellen, J., and Nagel, S.. “The Conditional CAPM Does Not Explain Asset-Pricing Anomalies.” Journal of Financial Economics, 82 (2006), 289–314.CrossRefGoogle Scholar
Lewellen, J.; Nagel, S.; and Shanken, J.. “A Skeptical Appraisal of Asset-Pricing Tests.” Journal of Financial Economics, 96 (2010), 175–194.CrossRefGoogle Scholar
Liew, J., and Vassalou, M.. “Can Book-to-Market, Size, and Momentum Be Risk Factors that Predict Economic Growth?” Journal of Financial Economics, 57 (2000), 221–245.CrossRefGoogle Scholar
Lintner, J. “The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets.” Review of Economics and Statistics, 47 (1965), 13–37.CrossRefGoogle Scholar
Lioui, A., and Poncet, P.. “Misunderstanding Risk and Return?” Working Paper, Ecole des Hautes Etudes Commerciales (2009).Google Scholar
Merton, R. C. “An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (1973), 867–887.CrossRefGoogle Scholar
Petkova, R. “Do the Fama–French Factors Proxy for Innovations in Predictive Variables?” Journal of Finance, 61 (2006), 581–612.CrossRefGoogle Scholar
Ross, S. A. “The Arbitrage Theory of Capital Asset Pricing.” Journal of Economic Theory, 13 (1976), 341–360.CrossRefGoogle Scholar
Sharpe, W. F. “Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance, 19 (1964), 425–442.Google Scholar
Vassalou, M. “News Related to Future GDP Growth as a Risk Factor in Equity Returns.” Journal of Financial Economics, 68 (2003), 47–73.CrossRefGoogle Scholar