Preliminary Work on the Effect of a Flagged Market Jump on an

Equity’s Beta

Junior Research Seminar

Economics 201FS

Outline

• Review

• Beta Estimate– Time Horizon– Leads/Lags– Shifting

• Objective/Timeline

Capital Asset Pricing Model

Return of Equity = Risk-free rate

+ (Beta * Market Premium)

Beta = Cov(Market Return, Equity Return) / Var(Market Return)

Assumptions:

(i) Market return and residual are uncorrelated

(ii) Residuals are mutually uncorrelated

(iii) Residuals are difference between actual return and predicted return

Beta Estimates

• In order to smooth out estimate:– Time Horizon for Beta = One Month

• In order to increase the estimate of Beta:– Method used from Scholes and Williams (1977)

Jan '01 Jan '02 Jan '03 Jan '04 Jan '05 Dec '050

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

January 2001 - December 2005

Bet

a

Market Beta for UPS

Average Beta: 0.4372

Jan '01 Jan '02 Jan '03 Jan '04 Jan '05 Dec '05-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

January 2001 - December 2005

UPS Beta

Average Beta Over Time Interval: .4017

Objective

• Introduce a dummy variable (Jmt), that depends on if the market (SPY) jumped– Lee/Mykland

• rcmt = (1-Jmt)(rmt)

• rjmt = (Jmt)(rmt)

rit = αi + βic (1-Jmt)(rmt) + βij (Jmt)(rmt) + εit

Timeline

• March 28: – Monthly Beta

• April 11: – Leads/Lags– Lee/Mykland– Shifting Beta

• April 25: Presentation of Results

• May 2: Final Report Due