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Explanations for the Instability of Equity Beta: Risk-Free Rate Changes and Leverage Effects

Published online by Cambridge University Press:  06 April 2009

Douglas V. DeJong  and
Daniel W. Collins
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Abstract

This paper is an initial attempt to bridge the gap that presently exists between the theoretical and empirical literature on the instability of equity beta. We focus on two factors from the joint Option Pricing Model/Capital Asset Pricing Model framework—leverage and unexpected changes in the risk-free rate—which are hypothesized to influence the instability of equity beta across firms and over time. Using alternative variable parameter regression models, we find that highly leveraged firms exhibit greater equity beta instability than firms with lower leverage. Over time, equity betas exhibit greater instability during periods of large unexpected changes in the risk-free rate when compared to periods with small unexpected changes in the risk-free rate.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 20 , Issue 1 , March 1985 , pp. 73 - 94
Copyright
Copyright © School of Business Administration, University of Washington 1985

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