Nonlinearities in the CAPM: Evidence from Developed and Emerging Markets

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NESLİHANOĞLU S., Sogiakas V., McColl J. H., Lee D.

JOURNAL OF FORECASTING, vol.36, no.8, pp.867-897, 2017 (SSCI) identifier identifier

  • Publication Type: Article / Article
  • Volume: 36 Issue: 8
  • Publication Date: 2017
  • Doi Number: 10.1002/for.2389
  • Journal Name: JOURNAL OF FORECASTING
  • Journal Indexes: Social Sciences Citation Index (SSCI), Scopus
  • Page Numbers: pp.867-897
  • Keywords: CAPM, time-varying market model, co-skewness and co-kurtosis, quadratic and cubic market model, RISK, EQUILIBRIUM, RETURNS, SKEWNESS, TESTS
  • Eskisehir Osmangazi University Affiliated: Yes

Abstract

This paper examines the forecasting ability of the nonlinear specifications of the market model. We propose a conditional two-moment market model with a time-varying systematic covariance (beta) risk in the form of a mean reverting process of the state-space model via the Kalman filter algorithm. In addition, we account for the systematic component of co-skewness and co-kurtosis by considering higher moments. The analysis is implemented using data from the stock indices of several developed and emerging stock markets. The empirical findings favour the time-varying market model approaches, which outperform linear model specifications both in terms of model fit and predictability. Precisely, higher moments are necessary for datasets that involve structural changes and/or market inefficiencies which are common in most of the emerging stock markets. Copyright (c) 2016 John Wiley & Sons, Ltd.