Hostname: page-component-78c5997874-j824f Total loading time: 0 Render date: 2024-11-14T04:40:29.917Z Has data issue: false hasContentIssue false
  • English
  • Français

Explanations for the Instability of Equity Beta: Risk-Free Rate Changes and Leverage Effects

Published online by Cambridge University Press:  06 April 2009

Douglas V. DeJong  and
Daniel W. Collins
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper is an initial attempt to bridge the gap that presently exists between the theoretical and empirical literature on the instability of equity beta. We focus on two factors from the joint Option Pricing Model/Capital Asset Pricing Model framework—leverage and unexpected changes in the risk-free rate—which are hypothesized to influence the instability of equity beta across firms and over time. Using alternative variable parameter regression models, we find that highly leveraged firms exhibit greater equity beta instability than firms with lower leverage. Over time, equity betas exhibit greater instability during periods of large unexpected changes in the risk-free rate when compared to periods with small unexpected changes in the risk-free rate.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 20 , Issue 1 , March 1985 , pp. 73 - 94
Copyright
Copyright © School of Business Administration, University of Washington 1985

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

[1]Beaver, William. “Market Prices, Financial Ratios, and the Prediction of Failure.” Journal of Accounting Research, Vol. 6(Autumn 1968), pp. 179–192.CrossRefGoogle Scholar
[2]Beaver, William; Kettler, Paul; and Scholes, Myron. “The Association between Market-Determined and Accounting-Determined Risk Measures.” Accounting Review, Vol. 45 (10 1970), pp. 654–682.Google Scholar
[3]Black, Fisher, and Scholes, Myron. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, Vol. 81 (05/06 1973), pp. 637–654.CrossRefGoogle Scholar
[4]Bogue, , Marcus, E. “The Estimation and Behavior of Systematic Risk.” Unpublished Ph.D. Dissertation, Stanford University (1973).Google Scholar
[5]Bradley, Michael, and Jarrell, Gregg. “Firm Risk, Default Costs and Optimal Capital Structure.” Working Paper Series No. GPB 81–5, Graduate School of Management, University of Rochester (03 1981).Google Scholar
[6]Chen, Son-Nan. “Beta Nonstationarity, Portfolio Residual Risk and Diversification.” Journal of Financial and Quantitative Analysis, Vol. 16 (03 1981), pp. 95–111.Google Scholar
[7]Cooley, Thomas, and Prescott, E.. “Varying Parameter Regression, A Theory and Some Applications.” Annals of Economic and Social Measurement, Vol. 2 (10 1973), pp. 463–474.Google Scholar
[8]Cooley, Thomas, and Prescott, E.. “Estimation in the Presence of Stochastic Parameter Variation.” Econometrica. Vol. 44 (01 1976), pp. 167–184.CrossRefGoogle Scholar
[9]Fabozzi, Frank, and Francis, Jack. “Beta as a Random Coefficient.” Journal of Financial and Quantitative Analysis, Vol. 13 (03 1978), pp, 101–116.CrossRefGoogle Scholar
[10]Fama, Eugene. “Short-Term Interest Rates as Predictors of Inflation.” American Economic Review, Vol. 65 (06 1975), pp. 269–282.Google Scholar
[11]Fama, Eugene. “Inflation Uncertainty and Expected Returns on Treasury Bills.” Journal of Political Economy, Vo. 84 (06 1976), pp. 427–449.CrossRefGoogle Scholar
[12]Fama, Eugene, and Schwert, G. William. “Asset Returns and Inflation.” Journal of Financial Economics, Vol. 4 (01 1977), pp. 115–146.CrossRefGoogle Scholar
[13]Fisher, Lawrence, and Kamin, Jules. “Forecasting Systematic Risk.” Working Paper No. 13, Center for Research in Security Prices, University of Chicago (05 1978).Google Scholar
[14]Galai, Dan, and Masulis, Ronald. “The Option Pricing Model and the Risk Factor of Stock.” Journal of Financial Economics, Vol. 3 (01/03 1976), pp. 53–81.Google Scholar
[15]Hamada, Robert. “The Effects of the Firm's Capital Structure on the Systematic Risk of Common Stocks.” Journal of Finance, Vol. 27 (05 1972), pp. 435–452.CrossRefGoogle Scholar
[16]Hildreth, Clifford, and Houck, James. “Some Estimators for a Linear Model with Random Coefficients.” Journal ofAmerican Statistical Society, Vol. 63 (06 1968), pp. 584–595.Google Scholar
[17]Klemkosky, Robert, and Martin, John.“The Effect of Market Risk on Portfolio Diversification.” Journal of Finance, Vol. 30 (03 1975), pp. 147–155.CrossRefGoogle Scholar
[18]Meiselman, D.The Term Structures of Interest Rates. New Jersey: Prentice-Hall Inc. (1962).Google Scholar
[19]Miller, Merton, and Scholes, Myron. “Rate of Return in Relationship to Risk: A Re-examination of Some Recent Findings.” In Studies in the Theory of Capital, Jensen, Michael, ed. New York: Praeger(1972).Google Scholar
[20]Ohlson, James, and Rosenberg, Barr. “Systematic Risk of the CRSP Equal-Weighted Common Stock Index: A History Estimated by Stochastic-Parameter Regression.” Journal of Business, Vol. 55 (01 1982), pp. 121–145.CrossRefGoogle Scholar
[21]Rosenberg, Barr. “The Analysis of a Cross-Section of Time Series by Stochastically Convergent Parameter Regression.” Annals of Economic and Social Measurement, Vol. 2 (10 1973), pp. 399–428.Google Scholar
[22]Schaefer, Stephen; Brealey, Richard; Hodges, Stewart; and Thomas, Howard. “Alternative Models of Systematic Risk.” Unpublished Manuscript, London Graduate School of Business Studies (1973).Google Scholar
[23]Scholes, Myron, and Williams, J.. “Estimating Betas from Nonsynchronous Data.” Journal of Financial Economics, Vol. 5 (09 1977), pp. 309–327.CrossRefGoogle Scholar
[24]Sunder, Shyam. “Stationarity of Market Risk: Random Coefficients Tests for Individual Stocks.” The Journal of Finance, Vol. 35 (09 1980), pp. 883–896.CrossRefGoogle Scholar
[25]Swamy, P. A. V. B. “Efficient Inference in a Random Coefficient Regression Model.” Econometrica, Vol. 38 (03 1970), pp. 311–323.Google Scholar
[26]Theil, Henri, and Mennes, L. B. M.. “Multiplicative Randomness in Time-Series Regression Analysis.” Mimeographed Report No. 5901 of the Econometric Institute of the Netherlands School of Economics (1959).Google Scholar
[27]Theil, Henri. Principles of Econometrics. New York: John Wiley and Sons, Inc. (1971).Google Scholar
[28]Van Home, J. C.The Function and Analysis of Capital Market Rates. New Jersey: Prentice-Hall Inc. (1970).Google Scholar