The Capital Asset Pricing
Model (CAPM) has been a key theory in financial economics since the 1960s. One
of its main contributions is to attempt to identify how the risk of a particular
stock is related to the risk of the overall stock market using the risk measure
Beta. If the relationship between an individual stock’s returns and the returns
of the market exhibit heteroskedasticity, then the estimates of Beta for
different quantiles of the relationship can be quite different. The behavioral
ideas first proposed by Kahneman and Tversky (1979), which they called prospect
theory, postulate that: (i) people exhibit “loss-aversion” in a gain frame; and (ii) people exhibit “risk-seeking” in a loss
frame.
If
this is true, people could prefer lower Beta stocks after they have experienced
a gain and higher Beta stocks after they have experienced a loss. Stocks that
exhibit converging heteroskedasticity (22.2% of our sample) should be preferred
by investors, and stocks that exhibit diverging heteroskedasticity (12.6% of our
sample) should not be preferred. Investors may be able to benefit by choosing
portfolios that are more closely aligned with their preferences.
The latest version of the paper in PDF format is available at J. Risk Financial Manag. 2014, 7, 67-79; doi:10.3390/jrfm7020067