Determinants of Market Beta: The Impacts of Firm-Specific Accounting Figures and Market Conditions

Abstract

This article examines and extends research on the relation between the capital asset pricing model (CAPM) market beta, accounting risk measures and macroeconomic risk factors. We employ a beta decomposition approach, that nests competing models with different business risk proxies and allows to frame cross-model comparison. Because model tests require estimated independent variables resulting in measurement error, we empirically estimate three comparable model specifications with instrumental variable estimators and for the first time provide thorough instrument diagnostics in this setting. Correcting for the heretofore neglected weak instruments problem we find that growth risk (i.e., the risk of firm sales variations that are inconsistent with the market wide trends), is the business risk that explains cross-sectional variations in market beta best.