Working Paper: NBER ID: w10413
Authors: Tano Santos; Pietro Veronesi
Abstract: Empirical evidence shows that conditional market betas vary substantially over time. Yet, little is known about the source of this variation, either theoretically or empirically. Within a general equilibrium model with multiple assets and a time varying aggregate equity premium, we show that conditional betas depend on (a) the level of the aggregate premium itself; (b) the level of the firm's expected dividend growth; and (c) the firm's fundamental risk, that is, the one pertaining to the covariation of the firm's cash-flows with the aggregate economy. Especially when fundamental risk (c) is strong, the model predicts that market betas should display a large time variation, that their cross-sectional dispersion should be negatively related to the aggregate premium, and that investments in physical capital should be positively related to changes in betas. These predictions find considerable support in the data.
Keywords: No keywords provided
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| level of the aggregate premium (G52) | cross-sectional dispersion of betas (C46) |
| cross-sectional dispersion of betas (C46) | capital investment growth (E22) |
| expected dividend growth (G35) | cross-sectional dispersion of betas (C46) |
| fundamental risk (D81) | fluctuations in market betas (E32) |
| cash flow risk (G32) | variation in betas (C46) |
| changes in betas (C46) | investment growth (E20) |