Heteroskedasticity in Stock Returns
University of Rochester, Rochester, NY 14627
and National Bureau of Economic Research
Paul J. Seguin
Michigan, Ann Arbor, MI 48109
Journal of Finance, 45 (September 1990) 1129-1155
We use predictions of aggregate stock return variances to estimate time-varying monthly variances
for size-ranked portfolios. We propose and test a single factor model of heteroskedasticity for portfolio
returns. This model implies time-varying betas. Implications of heteroskedasticity and time-varying betas
for tests of the Capital Asset Pricing Model (CAPM) are then documented. Accounting for heteroskedasticity
increases the evidence that risk-adjusted returns are related to firm size. Further, a constant correlation
model is proposed and tested. Disaggregate volatilities predicted by this model are similar to those
predicted by more complex multivariate generalized-autoregressive-conditional-heteroskedasticity (GARCH)
procedures.
Key words: Heteroskedasticity, Generalized least squares, Beta, Capital asset pricing model, Stock returns, Size effect
JEL Classifications: G12, G31
Cited 45 times in the SSCI through April 1996
© Copyright 1990, American Finance Association
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