G. William Schwert

University of Rochester, Rochester, NY 14627
and National Bureau of Economic Research

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Paul J. Seguin

Analytic Focus LLC

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Journal of Finance, 45 (September 1990) 1129-1155

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We use predictions of aggregate stock return variances to estimate time-varying monthly variances for size-ranked portfolios. We propose and test a single factor model of heteroskedasticity for portfolio returns. This model implies time-varying betas. Implications of heteroskedasticity and time-varying betas for tests of the Capital Asset Pricing Model (CAPM) are then documented. Accounting for heteroskedasticity increases the evidence that risk-adjusted returns are related to firm size. Further, a constant correlation model is proposed and tested. Disaggregate volatilities predicted by this model are similar to those predicted by more complex multivariate generalized-autoregressive-conditional-heteroskedasticity (GARCH) procedures.

Key words: Heteroskedasticity, Generalized least squares, Beta, Capital asset pricing model, Stock returns, Size effect

JEL Classifications: G12, G31

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Cited 179 times in the SSCI and SCOPUS through 2019

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© Copyright 1990, American Finance Association

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