In most empirical work on the market model, the parameters of that model are estimated by ordinary least squares, effectively assuming that the systematic risk of an asset, or portfolio, is constant through time. However, a plausible alternative hypothesis would allow the systematic risk of the stock of a company to vary through time. Such variation may arise through the influence of either microeconomic factors (such as operational changes in the company, or changes in the business environment peculiar to the company), or macroeconomic factors (such as the rate of inflation, general business conditions, and expectations about relevant future events). A detailed discussion of these points is provided by Rosenberg and Guy (1976a, 1976b). Support for the hypothesis that systematic risk varies through time is provided in the studies by Jacob (1971), Blume (1975), and Fabozzi and Francis (1978). In this paper we allow the possibility that systematic risk of an asset is stochastic. In principle, an attempt to model this stochastic behavior could be made through allowing systematic risk to follow a member of the general ARIMA class of models of Box and Jenkins (1970). Ideally, the available data would be employed to suggest a specific model from this general class. However, this approach has to face very serious We discuss the market model in which the possibility is allowed that beta is stochastic and obeys a first-order autoregressive process. Following a brief discussion of methodological issues in the estimation and testing of such models, results are reported on an empirical study of a large sample of monthly returns of common stock. We find strong evidence indicating stochastic systematic risk, but relatively little evidence against the random coefficient model.

An Empirical Investigation of the Possibility of Stochastic Systematic Risk in the Market Model

Ekonometryczne modelowanie procesów gospodarczych : modelowanie ze zmiennymi i losowymi parametrami

This paper discusses the behavior of futures prices for foreign exchange in Brazil during a period of high inflation and successive stabilization attempts (1989-92). After testing for futures prices unbiasedness and predicability by applying the Generalized Method of Moments, the paper argues that the finding of excess returns may be viewed as a rational response to the frequent and unpredictable changes in the exchange rate policy during that period. This response could reflect (i) an informational problem where the exchange rate policy is assumed to be unknown; or, (ii) a "peso" problem of rational (under) overprediction where the futures bias is the market response to the known policy of infrequent large nominal devaluations. The second line of explanation is suggested by conditioning the probability distribution of the excess return of futures contracts on the event of a major devaluation.

Infrequent Large Nominal Devaluations and Their Impact on the Futures Prices for Foreign Exchange in Brazil

This paper discusses the behavior of futures prices for foreign exchange in Brazil during a period of high inflation and successive stabilization attempts (1989-92). After testing for futures prices unbi­ asedness and predictability by applying the generalized method of moments, the paper argues that lhe finding of excess returns may be viewed as a rational response to the frequent and unpredictable changes in the exchange rate policy during that period. This response could reflect an informational problem where the exchange rate policy is assumed to be unknown; or, a "peso" problem of rational (under) overprediction where the futures bias is the market response to the known policy of infrequent large nominal devaluations. The second line of explanation is suggested by conditioning the probabil­ ity distribution of the excess return of futures contracts on the event of a major devaluation. o artigo discute o comportamento dos precos futuros da taxa de câmbio no Brasil durante um periodo de inflacao alta e' sucessivas tentativas de estabilizacao (1989-92). Apos testar a existencia de vies na formacao de expectativas e na antecipacao dos precos futuros para a taxa de câmbio via o metodo generalizado de momentos, o artigo propoe que os retornos excessivos no mercado futuro sejam vis­ tos como uma resposta racional a politica de desvalorizacoes infrequentes elou de mudancas nao-an­ tecipadas da politica cambial no periodo. Esta resposta pode refletir um problema de informacoes, em que a politica cambial e desconhecida; ou um "problema do tipo peso", isto e, super (sub) predicao, onde o vies futuro e a resposta racional do mercado a politica de grandes e infrequentes desvaloriza­ coes nominais da moeda. Esta segunda linha de explicacao e sugerida, condicionando a distribuicao de probabilidades dos retornos no mercado ao evento de uma desvalorizacao nominal.

Theodore Bos

Papers

Exact Maximum Likelihood Estimation of the Kalman Filter Model