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Conference of 2007
Finance Center Münster
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Although the CAPM has been empirically rejected, many previous papers find a conditional relation between market beta and return. In this study, we apply the conditional approach to the predominant model in asset pricing, the Fama-French three-factor model. Our results reveal that the size and book-to-market betas retain their explanatory power once the conditional nature of the relation between betas and return is taken into account. While other papers stop their analysis at this point, we derive a procedure to test if beta risk is priced within the conditional approach and show that the adjusted test leads to qualitatively identical results to the widely used Fama-MacBeth test.
Abstract
The Conditional Relation between Fama-French Betas and Return
Koch, Stefan; Westheide, ChristianAlthough the CAPM has been empirically rejected, many previous papers find a conditional relation between market beta and return. In this study, we apply the conditional approach to the predominant model in asset pricing, the Fama-French three-factor model. Our results reveal that the size and book-to-market betas retain their explanatory power once the conditional nature of the relation between betas and return is taken into account. While other papers stop their analysis at this point, we derive a procedure to test if beta risk is priced within the conditional approach and show that the adjusted test leads to qualitatively identical results to the widely used Fama-MacBeth test.