The Relative Efficiency of Beta Estimates

Jan Bartholdy email: jby@asb.dk and Paula Peare email: ppe@asb.dk Aarhus School of Business Fuglesangs Alle 4 8210 Aarhus V Denmark Abstract When estimation of beta is based on the Capital Asset Pricing Model the standard recommendation is to use five years of monthly data and a value-weighted index. Given the importance of the beta estimate obtained for financial decisions, such as those involved in portfolio management, capital budgeting, and performance evaluation, there is surprisingly little research evidence in support of this recommendation. The objective of this paper is to address this shortcoming. For this purpose the relative efficiency of beta estimates which result from using different data frequencies, time periods, and indexes is examined. It is found that five years of monthly data and an equal-weighted index, as opposed to the commonly recommended value-weighted index, provides the most efficient estimate.

Friday, March 16, 2001

A commercial provider of betas once told the authors that his firm, and others, did not know what the right period was, but they all decided to use five years in order to reduce the apparent differences between various services betas, because large differences reduced everyones credibility! (Brigham and Gapenski [1997], p354, footnote 9).

Introduction
Beta estimation is central to many financial decisions such as those relating to portfolio management, capital budgeting, and performance evaluation. Beta is also a key variable in the academic world; for example it is used for testing asset pricing models and market efficiency. Given the importance of this variable a pertinent question for both practitioners and academics is how to obtain an efficient estimate. When estimating beta based on CAPM the standard recommendation is to use five years of monthly data and a value-weighted index1. This procedure is widely used in academic studies as well as by commercial beta providers such as Merrill Lynch and Ibbotson and Associates2. There is, however, surprisingly little academic research evidence in support of this recommendation. As illustrated in the above quote the state of affairs is no better among professional beta providers. Further, despite such attempts to come up with similar betas, Bruner et al. [1998] found sizeable differences among beta providers. For their sample the average beta according to Bloomberg was 1.03 whereas according to Value Line it was 1.24. The main purpose of this paper is to address this shortcoming

Other issues relating to efficiency of beta estimates based on CAPM, in addition to what index and data frequency are appropriate, are also addressed here. These include, whether or not dividends should be included in the index, whether raw returns or excess returns should be used in the regression equation, and how efficiency should be measured. The results obtained suggest that using five years of monthly data and an equal-weighted index, as opposed to the commonly recommended value-weighted index, provides a more efficient beta estimate. Furthermore, it does not appear to matter whether dividends are included in the index or not or whether raw returns or excess returns are used in the regression equation.

There is a vast academic literature which rejects CAPM. This paper focuses on implementation of CAPM given its

widespread use as documented by Bruner [1998]. Whether or not it is the best model to use is a separate issue not addressed here..
2

See Reilly and Wright [1988] for a discussion of Merill Lynchs betas. A discussion of Ibbotson Associates Beta

Book can be found at the following address: www.ibbotson.com/Products/BetaBook/beta_sam.htm

These results are relevant for both practitioners and academics. Practitioners who use beta in financial decision making, to estimate cost of capital for example, need as accurate a beta as possible. For academics they provide a benchmark for more sophisticated models, such as multifactor models; before declaring beta dead, and praising the benefits of more complex models, we need to be sure that the dead beta is indeed the most efficient one. Also, to establish the benefits of more complex estimation techniques we need to ensure the beta obtained from simpler techniques is the most efficient one.

The remainder of the paper is organised as follows. Section 1 contains a discussion of various issues, relating to efficiency, which arise when estimation of beta is based on CAPM. Section 2 provides a description of the data used. Results from the empirical analysis are reported in Section 3 and Section 4 concludes the paper.

I. Estimation issues.
In this section a brief discussion of issues, relating to efficiency, which arise when estimation of beta is based on CAPM is provided. According to CAPM the expected return on an asset i is given by: E[r i ] = r f + M (E[r m ] r f ) i world market portfolio, M = i
2
Cov(r i ,r I ) o2 M

(1)

where r i denotes the return on asset i, r f , denotes the risk-free return, r m denotes the return on the is the systematic risk of asset i relative to the world market

portfolio, and o M is the variance of the return on the world market portfolio. An estimate for beta based on CAPM is typically obtained by running the following regression: r it = i + I r It + it i (2a)

using five years of monthly data and a value-weighted index, I, as a proxy for the world market portfolio. As discussed in the introduction there is little evidence concerning the efficiency of the resulting estimate for beta. The main purpose of this paper is address this shortcoming. In addition, the issue of whether or not dividends should be included in the index used is addressed. Finally, two measures of efficiency are considered. In summary, therefore, the following issues relating to the efficiency of beta estimates based on CAPM, are addressed in this paper: Do dividend adjustments in the index matter? Should excess returns or raw returns be used? What data frequency should be used, daily, weekly, or monthly, and for how long? 2

What is the best index to use? How should efficiency be measured?

Before discussing each of these issues in more detail, two important estimation issues not dealt with in this paper are clarified: thin trading and mean reversion in beta. Before obtaining efficient estimates for thinly traded stocks we need to find the best way of estimating beta for frequently traded stocks. Thus only frequently traded stocks are included in the sample analysed in this paper. With respect to mean reversion in beta, i.e. the tendency for a high beta to be followed by smaller beta, the method suggested by Blume [1975] for dealing with this is implicit in the procedure used here. None of the other methods designed to deal with mean reversion are considered. Again this is based on the argument that it is best to find the benchmark first before starting to compare various estimates and improvements. Finally, how a beta estimate is subsequently used is not addressed3. We now turn to a discussion of the issues listed above.

Dividends The theoretical model underlying CAPM assumes dividends are included in the returns on the world market portfolio. Given the number of indexes constructed without dividends it is relevant to ask if it matters, for estimation of beta, whether or not dividends are included in the index used. Therefore, where possible, indexes with and without dividends are considered here.

Excess Returns or Raw Returns As indicated above equation (2a) is commonly used when estimation of beta is based on CAPM. From the theoretical model for CAPM (equation (1) above) the right hand side is expressed in terms of excess market return (market return minus the risk-free rate). Subtracting the risk-free rate from both sides of (1) yields an expression with excess return on the left side as well. This means that a more general formulation for the regression equation is given by: r it r ft = i + i (r m r ft ) + it (2b)

It follows almost immediately that (2a) is a special case of this more general formulation; to obtain (2a) from (2b) it is necessary to assume that the risk-free rate is constant over the estimation period. In the final analysis which of these two is more appropriate for estimation of beta is an empirical question. Therefore both formulations are examined here.

In Bartholdy and Peare [2000] it is shown how to obtain an unbiased estimate for cost of equity from the resulting beta

estimate.

Data Frequency and Time Period In general when estimating a parameter the more observations the better. This suggests using as long a time period as possible. However, if the time period is too long then one runs into instability problems. If, for example, the true beta changes during the estimation period then the estimate obtained for beta will be biased. This pulls us in the direction of shortening the period. One way of obtaining more observations, over a shorter time period, is to increase the sampling frequency. However, if we move from monthly to daily returns, for example, then the amount of noise in the data increases, which reduces the efficiency of the estimates. Thus there is a trade off between time period and sampling frequency. In this paper, therefore, we examine the performance of monthly data for five years (the standard frequency used), weekly data for two years, and daily data for one year4.

Index The underlying theory for CAPM is quite specific in its recommendation of index; it specifies that a value-weighted index consisting of all the assets in the world should be used. Since only a small fraction of all assets in the world trade on stock exchanges it is impossible to construct such an index so a proxy must be used instead. As discussed in the introduction the general recommendation is a value-weighted index such as Standard and Poors Composite Index5. Equal-weighted indexes have also been used. The question is, however, which gives the most efficient estimate? In this paper seven different indexes are considered. In particular, an Economy Index is developed here, in an attempt to construct an alternative proxy index that is more closely related to the world market index than existing indexes.

To construct a proxy that is closely related to the world market index consider for a moment what a world market index would look like in a simple world where all assets are traded in a frictionless market6. The weight for an asset in the index would be the value of the asset divided by the total
4

A related issue discussed in the literature is the Interval Effect. Hawawini [1983], for example, suggests that betas

are affected by the interval used to calculate the returns due to thin trading (proxied by size of the firm). Reilly and Wright [1988] found a relationship between beta and size of the firm. The sample used in this paper is restricted to stocks that traded on more than 95% of the days in the relevant sub period (see section 2 for further discussion), thus avoiding this type of Interval Effect.
5

Merill Lynch uses the Standard and Poor 500 Composite Index and Value Line uses the NYSE Composite Index.

Reilly and Wright [1988] found no difference in estimated betas based on these two indexes. Therefore the NYSE Composite Index is not included in the analysis here.
6

There is, however, no guarantee that an index that is close to the efficient frontier of all assets in the world has a higher

value of all assets in the world. These weights are, of course, not observable but they can be proxied using the National Income Accounts. From these accounts it is possible to obtain the value of goods and services produced in each sector of the economy. As long as the value of the goods is correlated with the underlying value of the assets it is possible to use each sectors share of Gross Domestic Product (GDP) as a proxy for the weights in the world market portfolio7. The return on assets within each sector can be proxied by the return on an equal-weighted index of the stocks for each sector trading on the stock exchange. The standard value-weighted index differs from such an economy index if, for example, some industries have a larger share of the capitalisation on the stock exchange than their share in the economy, measured by their share of GDP for example. This situation may arise if there is asymmetric information between management and shareholders; these problems are more profound in some industries than in others. Firms with severe asymmetric information problems are funded by other means than the stock market, e.g. banks, whereas firms with fewer asymmetric problems can raise funds on a stock exchange. Also the companies represented on a stock exchange are in general larger than the average company size in the economy.

The one factor version of the Arbitrage Pricing Theory (APT) (Ross [1976]) and Breeden [1979]. and the Consumption based CAPM model (Breeden [1979]) both provide a possible justification for the Economy index. One possible interpretation of the APT is that the one factor included in the model is an economic state variable. One way to capture this is to construct an index that represents the economy. An alternative interpretation of such an index is provided by the consumption based capital asset pricing model. If consumption is related to the state of the economy then one can use an index representing the economy as a proxy for consumption and base beta estimation on this index.

Whatever index is used it is a proxy for the market portfolio. The question is which proxy provides the best estimate for beta. In this paper the following seven proxies are considered: an Economy Index (construction discussed further in Section 2), the Standard and Poor Composite Index (value-weighted) since it is the most commonly used, CRSP equal and value-weighted indexes, with and without dividends, representing broad based domestic indexes, and the Morgan Stanley Capital World Index (value-weighted) since this represents an alternative attempt to construct a world market index.
R-squared than existing indexes - it is an empirical question.
7

In theory it is possible to obtain the GDP accounts for all countries in the world and corresponding weights. However,

in this study only US data is used due to resource restrictions.

Evaluation Finally, it is necessary to decide what measure should be used to determine relative efficiency8. The two performance measures adopted in this paper are based on the following cross section regression: r it+1 r ft+1 = 0 i + 1,t+1 it + it i = 1, .., N (3)

The procedure for monthly data is as follows: starting with 1970 to 1974 (inclusive) beta is estimated using (2a) or (2b). This is done for each stock in the sample. Then the individual beta estimates are used in (3), as the explanatory variable, for 1975, i.e. the returns on the left hand side are the individual stock returns for 1975. The process is then repeated for each year from 1976 to 1996. The procedure for weekly and daily data is similar; except for weekly data, beta is estimated for two year periods so we start with 1973 and 1974, and for daily data one year periods are used, so we start with 1974. Thus (3) measures how much of the future variation in stock returns beta is able to explain. This replicates the situation where historical data is used to estimate future cost of capital (as done by many practitioners). Academics also use this procedure for testing different multifactor models and for establishing the existence of anomalies in stock returns.

From this procedure two possible evaluation criteria are obtained. The first criterion is the significance of the average estimated value obtained for 1,t+1 ; the average estimated risk premium. If this value is not significant and positive then beta is not able to explain the excess return on the left hand side. Thus significance of this value is a necessary condition for the model to be of any use. The second criterion is the average R-squared from (3). This is a direct measure of the ability of the beta estimate to explain differences in returns on individual stocks in the period following estimation9. Clearly a high R-squared is desirable. Previous research in this area has focused on reasons for differences in estimated betas between periods and the ability of historical betas to predict future betas10. What is important for both practitioners and academics, however, is not so much an estimated betas ability to predict next periods beta, but its ability to explain next periods returns and how much of the differences in stock returns can be explained by differences in their betas. From an academic point of view it is important that the beta used in tests of CAPM and various market anomalies explain as much as possible of the expected return. Otherwise CAPM he
8

Two related papers, Reilly and Wright [1988] and Carleton and Lakonishok [1985], do not address the issue of relative

efficiency. These papers are primarily concerned with establishing differences in beta and cost of equity estimates which result from the use of different estimation techniques.
9

Using R-squared as a yardstick for CAPM follows Roll [1988]. See for example Blume [1975], Klemkosky [1975], and Reilly and Wright [1988].

10

may be rejected in favour of other models or anomalies. Thus the R-squared from (3) is used here to rank the different beta estimates obtained11.

In summary, in this paper different beta estimates are obtained using five years of monthly data (the standard frequency used), two years of weekly data, and one year of daily data. Seven different indexes are considered as potential proxies for the world market portfolio. In addition, the issues of whether or not dividends should be included in the index, and whether or not excess or raw returns should be used when estimating beta, are examined. Finally, relative efficiency of the different estimates obtained is measured by significance of the average estimated value for 1,t+1 and the average R-squared value obtained from (3).

2. Data.
Daily adjusted prices were extracted from the CRSP tapes from 1970 to 1996. Daily returns were calculated as simple holding period rates of return between days12. Weekly returns were calculated from Wednesday to Wednesday to avoid any contaminating effects from weekends and Mondays and end of month prices were used for calculating monthly returns. Daily yields on 3 month T-bills were used for the risk-free rate. These were calculated at the beginning of the period; for example for the risk-free rate on Thursday the closing price/yield on the T-bill on Wednesday was used.

To avoid problems which result from thin trading and to keep the analysis manageable only stocks which traded on more than 95% of the days in the estimation and testing period were included. As discussed in section 1, for monthly data, the first step in the testing procedure is to estimate a beta for each stock using the years 1970 to 1974. Betas are also estimated for weekly data using 1973 and 1974 and for daily data using 1974. Thus the sample of stocks used for the monthly, weekly, and daily estimations is the same. Therefore for a stock to be included in the sample it must have traded on more than 95% of the days over a six year period. The number of stocks in the resulting sample ranges from a low of 780 in 1975 to a high of 1308 in 1994.

11

Most previous studies used portfolios when estimating (3) to avoid measurement error problems. However, the

portfolio approach is not appropriate when the purpose of obtaining a beta estimate is to estimate the cost of equity for a single company. Thus portfolios are not used in this paper.
12

Reilly and Wright [1988] found only a marginal difference in beta estimates from using log price relatives over simple

rate of return calculations. Thus only simple rate of return calculations are used in this paper.

Also from section 1, seven indexes are considered as potential proxies for the world market portfolio; the four CRSP indexes: value and equal-weighted with and without dividends, Standard and Poors Composite Index which is value-weighted, the Morgan Stanley Capital World Index which is also value-weighted, and an Economy index. The CRSP indexes were obtained from the CRSP tapes. Standard and Poors Composite Index and Morgan Stanleys Capital World Index were retrieved from Datastream. The Morgan Stanley Index in only available on a monthly basis for the whole period. The Economy index is constructed in the following manner. The SIC code is obtained for each stock in the sample from the CRSP tape and an equal-weighted index is calculated for each 2 digit SIC code. The GDP by Industry in current dollars for the period 1970 to 1996 is obtained from the Bureau of Economic Analysis. The industries in the GDP Product Table are matched with the SIC portfolios generated from the CRSP sample. The weight assigned to each SIC portfolio is total GDP for the associated industry divided by total private GDP13.

Descriptive statistics for the monthly returns, for each of the indexes, are provided in Table 1. The CRSP equal-weighted index has the largest return followed by the Economy index. The returns on the other indexes, which are all value-weighted, are significantly lower. This difference in returns is probably due to the higher weight given to large firms in value-weighted indexes; large firms in general have lower returns than smaller firms (small firm effect, see for example Banz [1981]).

Place Table 1 here please.

3. Empirical analysis.
In this section, we first determine whether or not dividend adjustments to the index used matter and whether raw or excess returns should be used for estimation. Then the issue of data frequency/time period is addressed. Finally, the relative efficiency of the various beta estimates obtained using different indexes and data frequencies/time periods is examined.

Dividends Table 2 provides the correlation coefficients between the different indexes. For both the equal-weighted and the value-weighted CRSP index, the correlation between the indexes with and
13

GDP has a private and a government component. To ensure that the weights add up to one only the private component

of the GDP is included.

without dividends is .999; the standard deviations of the two indexes are also very close (see Table 1). This suggests that for the purpose of estimating beta it is irrelevant whether or not dividend adjusted indexes are used. Therefore, for the remainder of the analysis in this paper For the rest of the only the CRSP indexes with dividends are used (since theory suggests dividends constitute an important part of the return on an asset.)

Place Table 2 here please.

Excess Returns or Raw Returns From section 1, to address the issue of whether excess returns or raw returns should be used for estimation the following two regression equations are examined: r it = i + i r It + it r it r fr = i + i (r It r ft ) + it t = 1, .., T, i = 1, .., N (2a) t = 1, .., T, i = 1, .., N (2b)

The only difference between these two equations is that with (2a) raw returns on the asset and the index are used for estimation whereas with (2b) excess returns are used. The results from estimation of (2a) and (2b) are shown in Table 3.

Place Table 3 here please.

From Table 3 it is clear that the difference between using excess and raw returns is minimal, regardless of the index and data frequency used. Also the correlation coefficients between the betas estimated using excess and raw returns is about 0.999 (not reported in the tables) for all indexes and data frequencies. This suggests that either raw or excess returns can be used when estimating beta. Since the theoretical model lends itself to expression in terms of excess returns, in the interest of saving space, only excess returns are used in the subsequent analysis.

Data Frequency and Time Period Also from Table 3, estimation using one year of daily data, two years of weekly data, and five years of monthly data, yields an average beta which ranges from a low of 0.77 to a high of 1.18. Since a total of 22,905 betas were estimated for each index and data frequency this is a significant difference. Using Standard and Poors index the average beta for daily returns is 0.77 increasing to 1.1 when monthly returns are used. The situation is similar for the CRSP value-weighted index; 0.89 for daily data and 1.12 for monthly data. For the CRSP equal-weighted index, however, the 9

largest average beta is obtained using daily returns (1.18) and the smallest using monthly returns (0.92). Similarly for the Economy Index daily data gives 0.95 and monthly data gives 0.86. Analysis for the Morgan Stanley Index is not possible since only monthly returns are available for the whole period. Since the difference between an equal and value-weighted index is the large weight given to smaller firms in the equal-weighted index this suggests small and large firms react differently to differences in data frequency; the beta is larger for small firms if daily returns are used and smaller if monthly returns are used whereas for large firms it is the opposite.

Table 4 contains the correlation coefficients for the betas estimates obtained using (2b), for different indexes and different data frequencies. Within each data frequency, the correlation between betas estimated using the CRSP value-weighted index and the Standard and Poors Index is very high (0.99 approx). The correlation between the betas estimated using the CRSP equal weighted index and the Economy Index, is also high, within each data frequency (between 0.96 and 0.99). For all indexes the correlation across data frequencies is relatively low. For example, for the Standard and Poor Index, the correlation between betas estimated using daily data and monthly data is only 0.52 and 0.69 between daily and weekly returns. This correlation drops even further for betas estimated using different indexes and frequencies. For example, the correlation between betas estimated using monthly data for the CRSP equal-weighted Index and daily data for the Standard and Poor Index is only 0.34. Thus there are large differences in estimated betas depending on the index and data frequency used. It is, therefore, relevant to examine the relative efficiency of these estimates.

Place Table 4 here please.

Evaluation: What index and data frequency provide a relatively efficient beta? As discussed in section 1 the significance of the average estimated value of 1,t+1 and the average R-squared value from the following cross-section regression: r it+1 r fr+1 = 0 i + 1,t+1 it + it , i = 1, .., N (3). provide two criteria for determining the relative efficiency of the different beta estimates obtained from (2b). The data frequency for the right hand side is annual data; this reflects the general use of the model for cost of equity calculations where annual returns are typically used; the results with monthly returns as the dependent variables are similar14.
14

The results from monthly returns are available upon request from the authors.

10

The average estimated values obtained for 1,t+1 from equation (3) are provided in Table 515,16. For the Economy Index the average estimated value for 1 is significant if either weekly data or monthly data are used. For the CRSP equal-weighted index the average estimated value of 1 is only significant if monthly data are used. For the other indexes the average estimated value for 1 is not significant. The highest average estimate for 1 is obtained if monthly data and the Economy Index are used (0.0786) followed by monthly data and the CRSP equal-weighted (0.0703); weekly data and the Economy Index gives 0.0679. Thus, based on significance of the average estimated value for 1,t+1 , either five years of monthly data and the equal-weighted CRSP Index or the Economy Index give the best estimates for beta; however the value obtained using the Economy Index and two years of weekly data is not all that different (0,0679).

Place Table 5 here please.

R-squared values obtained from estimating (3) using annual data for the dependent variable are reported in Table 6. For all indexes the average R-squared value tends to increase when moving from daily to monthly data. For all data frequencies the Economy Index and CRSP equal-weighted index give the highest average R-squared values; for both of these indexes the highest value is obtained if five years of monthly data is used, 0.0271 for the Economy Index and 0.0296 for the CRSP equal-weighted index. The values obtained for the value weighted indexes are not all that different. Taken together with the results from the significance of the average estimated value for 1 , however, the R -squared values provide further support for the use of five years of monthly data and either the Economy Index or the CRSP equal weighted index. The average R-squared values, for all data frequencies and indexes, are however very low; they indicate that at best beta explains on average 3% of excess return. For some individual years the R-squared value is a little higher; the highest value obtained is 11.73%. There are also some very low values; with two exceptions (0.41% and 0.02%) all indexes and data frequencies have a minimum R-squared value of 0.01%.

Place Table 6 here please.

15

For discussion of how to obtain an unbiased estimate for cost of equity making use of these values, see Bartholdy and

Peare [2000].
16

The average estimated values obtained for

0,t+1 are also reported in this table for completeness. With one exception 11

they are all insignificant; which is consistent with CAPM.

In summary, therefore, the general recommendation of using five years of monthly data to estimate beta appears to be reasonable. However, from the results obtained here, the Economy Index and the equal-weighted CRSP index appear to perform better than the value-weighted indexes examined (see Tables V and VI). Given the high correlation between the Economy Index and the CRSP equal-weighted index (see Table IV) it is probably irrelevant which one is used, in terms of performance of the beta estimate and it is easier to construct the CRSP equal-weighted index. It is, however, worth noting that there were a number of problems associated with the GDP figures for the service industries etc; solving these problems could lead to an even more efficient beta estimate using the Economy Index (future research).

5. Conclusion.
Given the prominence of beta in financial decision making and academic research there is surprisingly little research relating to the properties of the estimates obtained from the various methods used for estimation. The general recommendation for estimation of beta based on CAPM is to use five years of monthly data and a value-weighted index. From the analysis done in this paper, while five years of monthly data is appropriate, the Economy Index constructed here and the CRSP equal-weighted index provide more efficient estimates than the value-weighted indexes examined. Further, use of the Economy Index can be justified by a one factor APT model or the consumption based capital asset pricing model. The Economy Index is non trivial to construct but it is also established here that it is highly correlated with the CRSP equal-weighted index. Therefore from the results obtained it can be concluded that the use of five years of monthly data and the CRSP equal-weighted index provides a relatively efficient beta estimate. However, it is also found that the ability of beta to explain differences in returns in subsequent periods ranges from a low of 0.01% to a high of 11.73% across years, and at best 3% on average. Keeping in mind that the analysis was done for NYSE stocks only, and furthermore for stocks that trade more than 95% of the time, it is of concern that under such very favourable circumstances beta can explain so little of the differences in returns between stocks. Based on these results, i.e. efficient beta estimates, it may well be appropriate to declare beta dead, at least in relation to estimation for individual stocks.

12

Bibliography. Banz, R., [1981], The Relationship Between Return and Market Value of Common Stock. Journal of Financial Economics. Vol. 9, pp. 3-18. Bartholdy, J. and P. Peare [2000], Estimating cost of equity. Unpublished working paper, rhus School of Business. Blume, M. [1975], Betas and Their Regression Tendencies. Journal of Finance, Vol. 30(3), pp. 785-795. Bruner, R. F., K. Eades, R. Harris and R. Higgins [1998], Best Practices in Estimating the Cost of Capital: Survey and Synthesis. Financial Practice and Education. Vol. 8(1), 13-28. Brigham E. and L. Gapenski [1997]. Financial Management, Eighth edition, The Dryden Press. Carleton, W. and J. Lakonishok, [1985]. Risk and Return on Equity: The Use and Misuse of Historical Estimates. Financial Analyst Journal. Vol. 41(January-February), pp. 38-47. Klemkosky, R. and J. Martin, [1975]. The Adjustment of Beta Forecasts. Journal of Finance. Vol. 30(4), pp. 1123-1128. Hawawini, G. A., [1983]. Why Beta Shifts as the Return Interval Changes. Financial Analyst Journal. Vol. 39(May-June), pp 73-77. Reilly, F. and D. Wright, [1988], A Comparison of Published Betas. Journal of Portfolio Management. Spring, pp. 64-69. Roll, R. [1988]. R2. Journal of Finance. Vol. 43(2), pp. 541-566. Ross, S., [1976], The Arbitrage Pricing Theory of Capital Asset Pricing. Journal of Economic Theory. Vol. 13, pp. 341-360.

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Table 1. Summary Statistics Summary statistics are for monthly returns on the indexes expressed as percentages. Economy Index refers to the index constructed in this paper. Standard and Poor refers to the Standard and Poor Composite Index and Morgan Stanley refers to the Morgan Stanley World Market Capital Index. The equal and value-weighted indexes refer to the indexes included on the CRSP tape, with and without dividends. Index Economy index Standard and Poor Morgan Stanley Value-weighted incl. dividends Value-weighted excl. dividends Equal-weighted incl. dividends Equal-weighted excl. dividends Number of obs. 323 323 323 323 323 323 323 Mean 1.659 0.7626 0.7493 1.0619 0.7499 1.845 1.653 Standard deviation 6.1902 4.3578 4.0825 4.496 4.4798 5.7023 5.6975 Minimum -26.306 -21.763 -17.1242 -22.5006 -22.6758 -25.0866 -25.1587 Maximum 32.3537 16.3047 14.2656 16.5798 16.2516 30.2876 30.0282

14

Table 2 Pearson Correlation Coefficients between the indexes The Pearson correlation coefficients are calculated based on monthly returns for each of the indexes. Economy index refers to the index constructed in this paper. Standard and Poor (and S & P) refers to the Standard and Poor Composite Index and Morgan Stanley (and MSCI) refers to the Morgan Stanley World Market Capital Index. The equal and value-weighted indexes refer to the indexes included on the CRSP tape, with and without dividends. Economy S&P MSCI CRSP value-weighted Incl. Excl. Div. Div. 0.8845 0.8844 0.9883 0.8216 1 0.9897 0.8236 0.9993 1 CRSP equal-weighted Incl. Excl. Div. Div. 0.9732 0.9721 0.785 0.6853 0.8485 0.8506 1 0.7851 0.686 0.848 0.8504 0.9999 1

Economy index Standard and Poor Morgan Stanley Value-weighted incl. dividends Value-weighted excl. dividends Equal-weighted incl. dividends Equal-weighted excl. dividends

0.8244 1

0.7031 0.826 1

15

Table 3 Summary statistics for beta estimates. Beta is estimated using the following two formulations:

r it = i + i r It + it , t = 1, .., T, i = 1, .., N

(2a)

r it r fr = i + i (r It r ft ) + it , t = 1, .., T, i = 1, .., N (2b)

for each index, daily returns for one year, weekly returns for two years, and monthly returns for five years. Index Number Average Standard Minimum Maximum beta deviation Daily data Standard and Poors - raw returns 22,905 0.7689 0.4443 -4.4325 3.1312 Standard and Poors - excess returns 22,905 0.769 0.4443 -4.4319 3.1315 Economy - raw returns 22,905 0.9515 0.487 -3.9122 7.0251 Economy - excess returns 22,905 0.9515 0.4868 -3.9077 7.0235 CRSP value-weighted - raw returns 22,905 0.894 0.4906 -5.1533 3.4301 CRSP value-weighted - excess returns 22,905 0.894 0.4905 -5.1519 3.4304 CRSP equal-weighted - raw returns 22,905 1.1759 0.6092 -4.5204 6.2092 CRSP equal-weighted - excess returns 22,905 1.1758 0.609 -4.5076 6.2057 Weekly data Standard and Poors - raw returns 22,905 0.9632 0.4814 -1.7643 6.2034 Standard and Poors - excess returns 22,905 0.9638 0.4811 -1.7585 6.2188 Economy - raw returns 22,905 0.9299 0.4625 -1.0696 6.6427 Economy - excess returns 22,905 0.9299 0.4619 -1.0759 6.6588 CRSP value-weighted - raw returns 22,905 1.0157 0.5003 -1.5696 6.4917 CRSP value-weighted - excess returns 22,905 1.0162 0.4999 -1.5635 6.5091 CRSP equal-weighted - raw returns 22,905 1.0959 0.5563 -1.6406 7.8494 CRSP equal-weighted - excess returns 22,905 1.0954 0.5552 -1.6338 7.8728 Monthly Data 0.4804 -1.9192 0.4717 -1.9468 0.5188 -1.5127 0.5133 -1.5106 0.4258 -0.5919 0.4239 -0.556 0.486 -1.3255 0.4833 -1.3448 0.4753 -0.4561 0.4717 -0.4082

Standard and Poors - raw returns Standard and Poors - excess returns Morgan Stanley - raw returns Morgan Stanley - excess returns Economy - raw returns Economy - excess returns CRSP value-weighted - raw returns CRSP value-weighted - excess returns CRSP equal-weighted - raw returns CRSP equal-weighted - excess returns

22,905 22,905 22,905 22,905 22,905 22,905 22,905 22,905 22,905 22,905

1.0966 1.0982 0.9779 0.9765 0.8586 0.8594 1.1163 1.1173 0.9223 0.922

3.4897 3.4652 3.8536 3.8294 5.7946 5.8326 3.7755 3.7249 7.3414 7.26

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Table 5 Average Estimates for intercept and slope coefficients from (3). The coefficients are obtained from the following model:

r it r ft = 0 + 1 it1 + it

(3)

where beta is estimated using time series regressions for the previous periods. The dependent variable is the annual return on stock i minus the risk-free rate of return. The equation is estimated for each year using between 780 and 1308 stocks depending on the year. Shaded area indicates a significant coefficient at the 5% level. The standard deviation is the sample standard deviation of the individual annual estimates. 1 1 0 = N P i0 1 = N P i1 Average Estimate Daily data Standard and Poors Economy CRSP value-weighted CRSP equal-weighted Weekly data Standard and Poors Economy CRSP value-weighted CRSP equal-weighted Monthly data Standard and Poors Economy CRSP value-weighted CRSP equal-weighted Morgan Stanley 0.43 0.0205 0.0336 0.0216 0.0443 0.1429 0.1189 0.1381 0.1194 0.137 0.0375 0.0786 0.0442 0.0703 0.0401 0.1085 0.1654 0.118 0.1561 0.1164 0.0727 0.0455 0.0691 0.0429 0.0562 0.0562 0.0251 0.0529 0.0265 0.1643 0.1314 0.1617 0.1319 0.0296 0.0679 0.0307 0.0529 0.1162 0.1497 0.1164 0.1288 0.1676 0.1413 0.1659 0.1409 0.0148 0.0456 0.0169 0.0361 0.1116 0.1271 0.1055 0.1052 Standard deviation Average Estimate Standard deviation

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Table 6. R-squared Values for (3). The R-square is obtained from the following regression:

r it r ft = 0 + 1 it1 + it

(3)

where beta is estimated using time series regressions (2b) for the previous periods. The dependent variable is the annual return on stock i minus the risk-free rate of return. The equation is estimated for each year using between 780 and 1308 stocks depending on the year. Index Daily data Standard and Poors Economy CRSP value-weighted CRSP equal-weighted Weekly data Standard and Poors Economy CRSP value-weighted CRSP equal-weighted Monthly data Standard and Poors Economy CRSP value-weighted CRSP equal-weighted Morgan Stanley Average Standard deviation 0.0329 0.0322 0.0338 0.0327 0.0295 0.0305 0.0303 0.0319 0.0176 0.0266 0.0194 0.0296 0.0185 Minimum Maximum

0.0173 0.0211 0.018 0.0222 0.0179 0.0247 0.019 0.0264 0.016 0.0271 0.019 0.0296 0.0168

0.0041 0.0001 0.0001 0.0001 0.0002 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001 0.0001

0.1161 0.1081 0.1092 0.1164 0.0939 0.1044 0.0893 0.1173 0.0806 0.0909 0.0856 0.101 0.0752

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Table 4. Correlation of beta estimates across time and indexes. Each beta is estimated using the following model:

(2b) where rit is the gross return on stock i, rft is the yield on the risk-free asset, and rIt is the return on the index. Daily returns for one year, weekly returns for two years and monthly returns for five years, are used in the regressions. For each data frequency there are 22,905 estimated betas and the correlation coefficients are calculated as the simple correlation coefficients between the betas estimated for different data frequencies and indexes. Daily returns Weekly returns Monthly returns S&P EcoValue Equal S&P EcoValue Equal S&P EcoValue Equal Morgan nomy weight weight nomy weight weight nomy weight weight Stanley Daily returns Standard and Poor 1 0.8348 0.9875 0.7867 0.6923 0.5781 0.6816 0.555 0.5172 0.3845 0.5052 0.3448 0.4206 Economy 1 0.8929 0.9608 0.6954 0.7415 0.7194 0.7181 0.5403 0.5672 0.5552 0.5521 0.4428 Value-weighted 1 0.8544 0.7192 0.6352 0.719 0.6133 0.5332 0.4373 0.5306 0.4169 0.4245 Equal-weighted 1 0.6738 0.7341 0.7074 0.7388 0.5398 0.5831 0.5581 0.5784 0.4674 Weekly returns Standard and Poor 1 0.8843 0.9916 0.8473 0.6074 0.5485 0.6175 0.5234 0.4545 Economy 1 0.9247 0.979 0.6105 0.6995 0.6452 0.685 0.4758 Value-weighted 1 0.8961 0.6187 0.5902 0.6359 0.5677 0.4671 Equal-weighted 1 0.6075 0.7132 0.6468 0.7128 0.4859 Monthly returns Standard and Poor 1 0.8094 0.987 0.7695 0.8219 Economy 1 0.8689 0.9859 0.647 Value-weighted 1 0.8323 0.7829 Equal-weighted 1 0.6429 Morgan Stanley 1

r it r ft = i + i (r It r ft ) + it