A capital asset pricing model with time-varying betas: some results from the London Stock Exchange

Abstract

According to the capital asset pricing model (CAPM) developed originally by Sharpe (1964) and Lintner (1965), the required excess return on a risky asset is proportional to its non-diversifiable risk, for which a sufficient statistic is the covariance of the asset return with the return on the market portfolio. In the case where this covariance is zero, the risk is completely diversifiable and the required excess return over the safe rate of return is zero. Empirical tests of the CAPM have generally yielded results unfavourable to the model in its simplest form. In particular, variables other than the covariance of the return with the market return have been found to be significant in explaining the excess return—variables ranging from the own return variance to seasonal dummies (see Jensen (1972) or Schwert (1983) for surveys).