Despite their prominent place in financial theory and practice, the Capital Asset Pricing Model and beta have failed test after test to explain stock returns. Research by John Y. Campbell and Tuomo Vuolteenaho in "Bad Beta, Good Beta" cite the misspecification of beta as the reason for this failure. They measure beta as the sum of two components: a more influential "cash-flow" beta and a secondary "discount-rate" beta. This thesis creates a ratio between the overall beta of a stock and the cash-flow beta and uses an ordinary least squares regression model to determine its significance in interpreting overall returns to a stock. It hypothesizes that this ratio will better explain returns than overall beta alone, offering improvements for both investors and financial managers alike.
Bibliography : p. 63-65
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