The Effect of Market Volatility on the Capital Asset Pricing Model (CAPM) Beta

Abstract

This paper investigates the effect of market volatility on Capital Asset Pricing Model (CAPM) betas across different asset classes using index price series between 1990 and 2013. To do this, we regress returns on these assets on market portfolio returns interacted with market volatility. We emphasize the different relationship market volatility has with beta and correlation. Overall, we find that market volatility does have an effect on beta, and this effect is statistically significant for more assets when VIX is very high. The effect changes by asset class and depending on whether VIX is very high. When the market is functioning normally, an increase in market volatility predicts increases in beta for equities and HY debt; it predicts decreases in beta for Treasuries, IG debt, and currency pairs with dollar as the base. In a highly volatile market, betas for all asset classes become more positive, with the exception of Treasuries and the dollar.