Abstract
In this paper, we empirically show how wavelet decomposition can provide an easy vehicle to study the systematic risk properties of return series to serve as protocol for different traders who view the market with different time resolutions. By using the separate catalogue of Large Cap, Mid Cap and Small Cap stocks comprising S&P BSE-500 index of Indian capital market, we report that the conventional beta coefficients estimated from CAPM are essentially an average of wavelet betas but the later provides a resolution more appropriate and hence need to be considered in a realistic risk assessment of securities. Additionally, the wavelet beta coefficients for Large Cap stocks are found more stable than Mid and Small capitalized stocks. This paper is the first attempt of its kind to link the underlying methodology across different capitalized stocks to identify the precise beta in a complex market behavior.
Highlights
Multi-scale representations are more effective in characterising the time-frequency properties of financial return series
It is notable that these market participants operate on different time scales depending upon their requirements and the true dynamic structure of the relationship between variables might vary over different time scales
This paper provides a comprehensive insight about beta risk measurement by resorting to wavelet analysis as it allows one to evaluate simultaneous time-frequency varying features of the given return series within unified framework
Summary
Multi-scale representations are more effective in characterising the time-frequency properties of financial return series. It is rather more practical and reliable in view of the large number of investors who participate in the stock market and take decisions over different time periods. The model builds on Markowitz (1952, 1959) mean variance portfolio theory and conveys the notion that securities are priced such that the expected returns will compensate investors for the expected risks. The CAPM presumes investors to be utility maximising agents and allows predicting the return of an asset for its given level of systematic risk measured through beta coefficient. Very often evidence showed the inability of the CAPM to identify the true beta that would allow investors to price risky securities in order to determine the desirability of an investment.
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