A conditional higher-moment CAPM

Vendrame, Vasco; Guermat, Cherif; Tucker, Jon

Abstract

This paper investigates whether dynamic and moment extensions to the traditional CAPM can improve its empirical performance and offer some alternative explanation to the cross-section of average returns on portfolios of stocks double sorted on book-to-market ratios and size. We consider three extensions. First, we introduce time-varying factor loadings obtained from a multivariate GARCH and dynamic conditional correlations. Second, we extend the model to a four-moment CAPM, which incorporates coskewness and cokurtosis. Finally, we allow for time-varying risk premia, based on a Markov-switching process. Our results confirm that the higher-moment CAPM does not perform well in its unconditional version, but its performance is significantly improved when we introduce a conditional version that accounts for both time-varying factor loadings and time-varying risk premia. The four-moment CAPM tests lead to a positive total risk premium estimate of 0.67% per month over the period 1926–2021, with all risk premia (beta, coskewness, and cokurtosis) exhibiting the expected theoretical signs.

• Journal Article Type: Article
• Acceptance Date: Jan 9, 2023
• Online Publication Date: Jan 13, 2023
• Publication Date: Mar 1, 2023
• Deposit Date: Jan 14, 2023
• Publicly Available Date: Jan 16, 2023
• Journal: International Review of Financial Analysis
• Print ISSN: 1057-5219
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 86
• Pages: 102524
• DOI: https://doi.org/10.1016/j.irfa.2023.102524
• Keywords: Finance; CAPM; Higher-moments; Conditional models; Regime switching
• Public URL: https://uwe-repository.worktribe.com/output/10346237
• Publisher URL: https://www.sciencedirect.com/science/article/pii/S1057521923000406?via%3Dihub
• Additional Information: This article is maintained by: Elsevier; Article Title: A conditional higher-moment CAPM; Journal Title: International Review of Financial Analysis; CrossRef DOI link to publisher maintained version: https://doi.org/10.1016/j.irfa.2023.102524; Content Type: article; Copyright: © 2023 The Authors. Published by Elsevier Inc.