Estimating security betas using prior information based on firm fundamentals

• Autores: Mathijs Cosemans, Rik Frehen, Peter C. Schotman, Rob Bauer
• Localización: Review of Financial Studies, ISSN-e 1465-7368, Vol. 29, Nº. 4, 2016, págs. 1072-1112
• Idioma: inglés
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• Resumen

  • We propose a hybrid approach for estimating beta that shrinks rolling window estimates toward firm-specific priors motivated by economic theory. Our method yields superior forecasts of beta that have important practical implications. First, unlike standard rolling window betas, hybrid betas carry a significant price of risk in the cross-section even after controlling for characteristics. Second, the hybrid approach offers statistically and economically significant out-of-sample benefits for investors who use factor models to construct optimal portfolios. We show that the hybrid estimator outperforms existing estimators because shrinkage toward a fundamentals-based prior is effective in reducing measurement noise in extreme beta estimates.