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On tests of the conditional relationship between beta and returns

Journal

Applied Financial Economics

Subject

Finance

Publishing details

Applied Financial Economics 2009 Vol 19:6 p 427-432

Authors / Editors

Cooper I A

Biographies

Ian Cooper

Publication Year

2009

Abstract

The Pettengill et al. (1995) test of the conditional relationship between beta and returns has recently become widely used. This article shows that there is a large bias in that test. The test is almost guaranteed to be satisfied, regardless of the model that generates expected returns. In particular, even if the Capital Asset Pricing Model (CAPM) is not true and expected returns and beta are unrelated, the test will detect statistically significant results of the size that they report in line with their hypothesis. The reason for the bias is that the ex post selection criterion used to partition data automatically generates coefficient values that the test interprets as being evidence in favour of the CAPM.

Publication Research Centre

Institute of Finance and Accounting

Available on ECCH

No


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