IIMB Management Review (2021) 33, 50–63

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Time-varying beta, market volatility and stress:

A comparison between the United States and
India
Gagari Chakrabartia,*, Ria Dasb

a
Department of Economics, Presidency University, Kolkata, West Bengal, India
b
Deloitte Haskins & Sells, Kolkata, West Bengal, India

Received 19 February 2018; revised form 24 December 2018; accepted 6 March 2021; Available online 23 March 2021

KEYWORDS Abstract This study examines the time-varying nature of industry betas in India and the United
Time-varying beta; States to explore whether their observed behaviours are independent of the extent of development of
Market risk; the financial market. Such betas relate to the movements, particularly volatility and stresses, in the
Volatility; relevant markets. During 1999–2017, we found significant transmission of volatility from the domestic
Stress index; market to the time-varying betas in both countries. The emerging market betas are further found to
MV GARCH model increase under the domestic market stress. The developed market betas, however, were able to avoid
market stresses or fall under stresses, thereby reducing the investment risk.
© 2021 Published by Elsevier Ltd on behalf of Indian Institute of Management Bangalore. This is an open
access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/)

Introduction follows: (1) systematic or non-diversifiable market risk and

The standard portfolio construction theory recognises that var-
ious financial assets respond differently to diverse economic
events because they possess unique risk–return profiles. A
diversified portfolio is based on the idea of combining various
such asset classes, each with distinct attributes. However, a
rational and risk-averse investor's best choice is always a port-
folio composed of less-risky assets that provide high return: a
“perfect” portfolio that is very difficult, if not impossible, to
construct. Hence, an investor is concerned about how to pick
up assets to construct a portfolio that replicates or closely
resembles the perfect one?
Literature shows that expected excess return to any asset
is considered a function of its risk, which is categorised as
*Corresponding author: Contact number: 9830243185.
E-mail address: gagari_chakrabarti@yahoo.com (G. Chakrabarti).
https://doi.org/10.1016/j.iimb.2021.03.003
0970-3896 © 2021 Published by Elsevier Ltd on behalf of Indian Institute of Management Bangalore. This is an open access article under the CC
BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/)
(2) unsystematic or asset-specific unique risk that might be
diversified by increasing the number of assets in a portfolio.
In case a portfolio is well diversified, it is the market risk,
rather than a unique risk that is considered. Such market
risks, following Sharpe (1964), may be quantified by the cor-
relation between asset returns or asset betas.
The widely used capital asset pricing model (CAPM)
(Sharpe, 1964) considered an asset's expected excess return
to be proportional to the expected excess return to the mar-
ket and, thus, introduced “beta” as the covariance between
the selected asset return and the market return in propor-
tion to the market return variance. Hence, beta measures
the responsiveness of such asset return to market move-
ments or market risk, which the model considers constant
over time. Given that investors are concerned about the
market risk, betas help construct portfolios by allowing
selection among various assets.
Time-varying beta, volatility and stress
Subsequent literature challenged the ideas advocated by
CAPM by questioning its effectiveness to explain cross-sec-
tional anomalies in the expected asset returns. Specifically,
the assumption of a constant beta was aggressively criticised
and strong cases for considering beta as time dependent
were established (Agarwal & Mangla, 2014; Basu &
Stremme, 2007; Bos & Newbold, 1984; Brooks, Faff, & Lee,
1992; Collins, Ledolter, & Rayburn, 1987; Fabozzi & Fran-
cis, 1978; Ferson & Harvey, 1991; Jagannathan &
Wang, 1996; Ohlson & Rosenberg, 1982).
Such modifications are important as the models with a
time-varying beta can explain much of the observed cross-
sectional dispersion in an expected asset return without
introducing additional factors, as emphasised by Fama and
French (1993, 1995) and Carhart (1997). Different stock mar-
ket anomalies, such as the book-to-market effects, size pre-
mium or the profitability of momentum, can be considered
once beta is varied over time (Avramov & Chordia, 2004;
Ball & Kothari, 1989; Black & Fraser, 2000; Campbell & Vuol-
teenaho, 2004; Chan & Chen, 1988; Fama & French, 1997;
Ferson & Harvey, 1999; Fraser, Hamelink, Hoesli, & Macgre-
gor, 2000; Groenewold & Fraser, 1999). Furthermore, the
time-varying betas can better explain the description of
return behaviour (Longstaff, 1989).
Berk, Green, and Naik (1999) modelled the time-varying
betas of firms in the presence of growth opportunities and
found that betas depend on the business cycles. However,
the betas of the different assets move differently over such
business cycles (Jagannathan & Wang, 1996; Lettau & Lud-
vigson, 2001; Petkova & Zhang, 2005). Gomes, Kogan, and
Zhang (2003) found that the betas depend on the business
cycle and factors such as firm size and market-to-book ratio.
Although there is a need for a time-varying beta, the dis-
cussions on the choice of a suitable method for estimation
remain inconclusive (Nieto, Orbe, & Ainhoa, 2014).
Lewellen and Nagel (2006) stated that allowing for condi-
tional time-varying dynamics may not overcome the prob-
lems associated with the traditional CAPM. It is crucial to
make appropriate assumptions about the unobservable con-
ditional information set of the investors for such estimation.
Literature suggests two frameworks: one makes assumptions
about the dynamics of beta, while the other relates to the
conditional covariance matrix of the return series (Nieto
et al., 2014). Some studies suggesting the first alternative
have used the Kalman filter to estimate beta on the assump-
tion that beta dynamics are determined by stochastic pro-
cesses (Mergner & Bulla, 2008; Moonis & Shah, 2003;
Wells, 1994), while others have followed parametric
approaches to estimate beta as depending on either state
variables (Shanken, 1990) or firm-level parameters (Jagan-
nathan & Wang, 1996; Lettau & Ludvigson, 2001).
Ferreira, Gil, and Orbe (2011) used a non-parametric
approach for estimating the same. Lin, Chen, and
Boot (1992) and Lin and Lin (2000) considered betas as linear
and parabolic functions of time. Literature, however, fails
to comment on the relative desirability of these methods.
Esteban and Orbe (2010), Li and Yang (2011), and Ang and
Kristensen (2012) non-parametrically estimated time-vary-
ing betas using the rolling least squares methods. This
approach is likely to overcome the problem of misspecifica-
tion that arises from choosing a particular functional form.
However, it involves the crucial choice of window length.
51
Studies that suggest the second alternative estimate the
time-varying beta using multivariate GARCH models in vari-
ous forms (Bollerslev, Engle, & Wooldridge, 1988;
Choudhry, 2005; Choudhry & Wu, 2008; De Santis &
G
erard, 1998; Ng, 1991). There is, however, no conclusive
proof to justify the choice of one technique over the other
(Choudhry & Wu, 2008; Ebner & Neumann, 2005;
Faff, Hillier, & Hillier, 2000).
Accepting a beta to be time variant adds another dimen-
sion to the investment decision behaviour (Gonzales-Riv-
era, 1996, 1997). A time-varying beta might represent
additional market risk or idiosyncrasies that could jeopar-
dise the choice of the perfect portfolio. Efficient prediction
of a beta is, hence, necessary to help investors make effi-
cient choices.
The present study
The present study examines the time-varying nature of beta,
if any, in the context of two countries, namely, India and the
United States, to explore whether the observed behaviours
of beta are independent of the extent of development in the
financial markets. Ronzani et al. (2017) stated that different
stocks follow (usually within a single country) different
dynamism in the evolution of their betas over time. While
such a dynamic nature of market risk, as evidenced by their
dynamic betas, is important for investors who seek to mini-
mise market risks, further dimensions may be added to their
investment decisions if such risks vary among markets, par-
ticularly among those that differ significantly in terms of
financial development. Efficiency in international portfolio
diversification requires a clear comprehension of the asset
price movements in the global markets. An investor, who
intends to keep a particular asset in the portfolio, is likely to
design his or her investment decision differently if the asset
behaves similarly, and not otherwise, in different markets.
Hence, examining various possible differences in the
observed behaviour of betas across financial markets has sig-
nificant implications for academicians and investors who
seek to operate at a global level. Hence, this study selects
two financial markets that are at the two extreme ends of
financial development. According to the World Bank (2018)
report on financial development ranking of countries, the US
market scores high in terms of indexes of Business Freedom
(82.7), Trade Freedom (86.7), Investment Freedom (85) and
Financial Freedom (80) compared with India's scoring of
56.4, 72.4, 40 and 40, respectively. The choice of the coun-
tries in this study is further justified by their world ranking
in terms of the Index of Economic Freedom that stands at 18
and 130 for the United States and India, respectively.
This study contributes to the literature by relating such
time-varying asset betas to the movements, particularly to
the volatility and stresses in the underlying or relevant mar-
kets. While literature finds additional idiosyncratic risks
associated with the time-dependent betas, it overlooks the
possibility that such betas might respond, even asymmetri-
cally, to the movements in the underlying market. There-
fore, the implications for investors to have changes in time-
varying betas to be sensitive to market movements would
differ from the cases where the beta is either considered a
constant or independent of market movement even if it
52
varies. The possibilities of having a series of significantly
higher betas during extreme market volatility or market
stress would add to the investment risk, which investors
might find difficult, if not impossible to hedge. Moreover,
with growing financial integration, the global market along
with its domestic counterpart will probably have serious
implications for asset betas and, hence, for the resultant
investment risk.
This study focuses on six important sectors or industries
from both countries using an 18-year daily database from 1
February 1999 to 31 January 2017. This period is characterised
by two significant financial crises, namely, the 2000–2001 dot-
com crisis and the 2007–2008 global financial meltdown. The
study examines the movements in the time-varying beta during
such volatility and stress in the financial market to understand
the significance of considering the beta to be time varying
rather than constant, from an investor's perspective. Specifi-
cally, the study addresses the following issues:
Q1: Should the industry betas be considered time varying
rather than constant? This question finds relevance in the avail-
able literature that suggests considering beta as time variant
(Bos & Newbold, 1984; Brooks et al., 1992; Collins et al., 1987;
Fabozzi & Francis, 1978; Gonzales-Rivera, 1996, 1997; Ohlson
& Rosenberg, 1982). Such assertion seems valid as the static
beta CAPM finds very little empirical support and applicability
(Agarwal & Mangla, 2014; Alam, Chowdhury, & Chowdhury,
2015; Holthausen & Hughes, 1978).
Q2: If the beta is indeed time varying, how do we calcu-
late it? This issue is much debated in the presence of alter-
native models in the field. In literature, bivariate GARCH,
BEKK, GARCH-GJR or the GARCH-X is used to model time-
varying betas (Bodurtha & Mark, 1991; Bollerslev et al.,
1988; Brooks et al., 1992; Engle & Rodrigues, 1989; Gianno-
poulos, 1995; Gonzales-Rivera, 1997; Koutmos, Lee, & Theo-
dossiou, 1994; Ng, 1991; Yun, 2002). Other studies have used
an alternative modelling technique, namely, the Kalman fil-
ter (Black, Fraser, & Power, 1992; Faff et al., 2000;
Well, 1994). Schwert and Seguin (1990) suggested an alter-
native market model with time-varying beta.
Faff et al. (2000), however, found no significant difference
when the method of computing differed.
Q3: If the beta changes over time, how does its move-
ment relate to the different phases of instability in the mar-
ket? Such markets involve both local and global markets
because in an era of financial integration, ignoring possibili-
ties of volatility spillovers from other markets might affect
the robustness of the results derived. The question finds rel-
evance because in the cases where market volatilities
directly affect a beta so that the relevant asset return
responds more intensely to the changes in market returns
when market returns are highly volatile, might add to the
investment risk. While studies by Berk et al. (1999),
Jagannathan and Wang (1996), Lettau and Ludvigson (2001),
Gomes et al. (2003) and Petkova and Zhang (2005) found
that betas depend on business cycle, these rarely associated
the betas with market volatilities. The impacts from local
and global markets were not separately analysed either.
The issue is discussed in further detail in the following
question.
Q4: How does a beta behave when the underlying rele-
vant market/s is (are) under stress? The question finds its
relevance because a volatile market does not always mean
G. Chakrabarti, R. Das
stressed market. An equity market is under stress when its
return at any time falls below a floor established by past
returns defined over a window. An increase in investment
risk might be feared when the betas are related to market
stress, particularly if they increase when a market plunges
into stress. Although several studies (e.g.,
Cardarelli, Elekdag, & Lall, 2009; Hakkio & Keeton, 2009;
Hollo
, Kremer, & Lo Duca, 2012) have analysed the issues
related to market stress, no attempt has thus far been made
to relate the time-varying betas to the local and global mar-
ket stresses.
Q5: Are the observed behaviours of beta independent of
the extent of development in the financial markets? The
question gains significance when investors operate globally.
When the time-varying beta of a particular industry behaves
differently in two markets at different levels of financial
market development, there are possibilities of arbitrage.
Investors may choose among the sectors not only within a
country but also across countries. This would help them min-
imise the otherwise non-diversifiable risks.
Data and methodology
This study selects six industries, namely, transportation,
healthcare, information technology, industrials, banks, and
telecommunications, from the Indian and the US market.
The Bombay Stock Exchange has introduced sectoral indices
since 1999. The study uses daily data on such indices from 1
February 1999 to 31 January 2017. The US data have been
collected from the official website of the National Associa-
tion of Securities Dealers Automated Quotations (NASDAQ).
Data on sectoral indices introduced after 1999 have been
collected from the date of their inception. The choice of
sectors or industries is contingent on the availability of the
common sector data for both countries.
The risk-free return has been obtained from the 91-day
treasury bill rate (annualised) from RBI and Federal Reserve
websites. BSE SENSEX, the benchmark index for Indian mar-
ket, comprising the 30 most valuable stocks, is the domestic
market proxy for India. The domestic market proxy for the
US sectors has been the Dow Jones Industrial Average of 30
stocks. The study takes Global Dow (GDOW) Index, the 150-
stock index of corporations from around the world, as the
global market proxy.
The daily returns are calculated using the logarithmic fil-
ter Rt = ln(Pt/Pt
1), where Pt is the industry index value at
the t-th period.
The constant beta CAPM
The constant beta CAPM (Sharpe, 1964) is the basic model
that is popularly used across the world to calculate expected
returns of stocks. The model in its original form may be
described as follows.


Ri
Rf ¼ bi Rm
Rf ð1Þ
where Ri is the ith stock return; Rm is the market return; Rf is
the risk-free return and bi is the market sensitivity of the ith
stock. However, some studies have questioned the use of the
OLS method to estimate such a model to comment on non-
diversifiable risks, particularly because the assumption of
Time-varying beta, volatility and stress 53

homoscedasticity may be violated, leading to the ineffi- suitable GARCH model in our study that works with 4551
ciency of the OLS estimator and to the betas not being accu- observations.
rately measured (Blume, 1971; Lin, Chen, & Boot, 1992; We use a suitably lagged diagonal VECH model for calcu-
Theil, 1971). Subsequently, studies have addressed the prob- lating the beta (Bollerslev, 1990; Bollerslev et al., 1988). A
lem by estimating a suitable ARCH model (Bera, Bubnys, & bivariate specification is used with the following specifica-
Park, 1988; Diebold, Im, & Lee, 1988) or GARCH model tion:
(Corhay, Rad, & Urbain, 1993). This study uses the GARCH
VECH ðHt Þ ¼ C þ A  VECH ðξ t
1 ξ 0 t
1 Þ þ B  VECH ðHt
1 Þ ð3Þ
(1,1) model, based on the minimum Akaike Information Cri-
terion (AIC) to estimate (1). 

The GARCH (1,1) specification includes mean and vari- ξ t ct
1 e Nð0; Ht Þ
ance equations as follows:
Mean equation : Yt ¼ xt0 u þ et ð2aÞ where VECH (Ht) is a vector half operator, stacking the lower
triangular of the symmetric Ht , a N £ N time-varying condi-
tional variance–covariance matrix.
Variance equation : s 2t ¼ v þ ae2t
1 þ bs 2t
1 ð2bÞ
2 3
h11t . . . h1Nt
The mean equation includes (Rm
Rf) as an exogenous
Ht ¼ 4 . . . . . . . . . 5
variable. The variance equation includes the conditional
variance s 2t that depends on three terms: (i) the one-period- hN1t ... hNNt
ahead forecast variance as a function of the lag of the If N = 2, a VECH(1,1) can be written as
squared residual from the mean equation e2t
1 (the ARCH 2 3 2 3 2 32 3
term), (ii) the last period's forecast variance s 2t
1 (the h11;t c11 a11 a12 a13 21; t
1
GARCH term) and (iii) a constant. 4 h21;t 5 ¼ 4 c21 5 þ 4 a21 a22 a23 56 4 1; t
1 ; 2: t
1
7
5
h22;t c22 a31 a32 a33 22; t
1
The phases of sectoral movement and the betas 2 32 3
b11 b12 b13 h11;t
1
þ 4 b21 b22 b23 54 h21;t
1 5
To justify the use of the time-varying beta, we isolate different b31 b32 b33 h21;t
1
phases in the movements of the chosen indexes on the basis of
introspection. To check whether betas vary over such phases of aii, the diagonal elements, show the own spillover or the
market movements, the constant CAPM betas are estimated impact of own past innovations on the present volatility. The
separately for each phase using suitable GARCH models on the cross-diagonal terms (aij, i6¼j) show the impact of past inno-
basis of AIC criterion. If the betas differ significantly from one vation in one asset return on the present volatility of other
phase to another, the market risk may be assumed to be returns. Similarly, bii shows the impact of own past volatility
depending on market movement, justifying, thereby, the need on the present volatility and bij represents the cross-volatil-
to make the beta time varying rather than constant. To check ity spillover, that is, the impact of past volatility of one asset
for the redundancy of the constant beta CAPM, we focus on return on the present volatility of others’ returns.
the decomposition of the mean squared forecast error into ct
1 is the information set at time t
1, C is a N(N+1)/2 £
bias, variance, and covariance proportions. In case of a good 1 parameter vector, A and B are N(N+1)/2 £ N(N+1)/2
forecasting, the bias and variance proportions should be small parameter matrices. Considering the off-diagonal of the
such that most of the bias should be concentrated on the coefficient matrices A and B as 0, the conditional variances
covariance proportions. Hence, if the constant CAPM beta can be expressed as
model appears with a poor covariance proportion of the mean h11;t ¼ c11 þ a11 e21; þ b11 h11;t
1
t
1
squared forecast error and if the betas are found to differ sig-
nificantly over the phases, a stage for establishing time-variant
betas may be set. h22;t ¼ c22 þ a33 e22; t
1 þ b33 h22;t
1

and by assuming the correlations between the conditional

The time-varying beta variances constant

1=2
Time-varying betas are calculated using a diagonal VECH h12;t ¼ r12 þ h11;t X h22;t
multivariate GARCH model. The selection of the model is Additionally, assuming all aii 0, all bii 0 and all cii> 0, the
justified on two grounds. First, studies (e.g., Faff et al., conditional beta is calculated as
2000) have documented no significant difference in the

results with a change in the method for computing betas to Conditional Cov Rgreen ; Rmarket
bt ¼ ð4Þ
the Kalman filter; second, different GARCH family models Conditional VarðRmarket Þ
are found to capture the volatility dynamics well in the
Conditional Var(Rmarket) is estimated from h22;t and Condi-
Indian and US stock markets (e.g., Joshi, 2011; Joshi & Pan-
tional cov (Rgreen, Rmarket) is estimated from h12;t .
dya, 2008; Malik, 2011; Mohanty & Kamaiah, 2000;
This study calculates the domestic beta for each industry
Kaur, 2004; Padhi, 2006; Schwert, 1990; Whitelaw, 1994).
by estimating (1). For the Indian market, BSE SENSEX is con-
Moreover, Koutmos (2012) and Ronzani et al. (2017) showed
sidered the proxy for the domestic market and Dow Jones
that the method for applying the GARCH models to compute
Industrial Average is considered the proxy for the US domes-
the time-varying betas yields consistent results with a large
tic market.
number of data points. This further justifies the use of a
54
Beta and market volatility
To verify whether the betas are related to market volatility, this
study uses a suitable bivariate GARCH model as the one given in
(3), specifically to explore whether volatility in the relevant
markets spills over to the time-varying beta. Hence, the mean
equation contains a time-varying beta as the explained variable,
with the conditional variance of (Rm
Rf) as the explanatory
variable. The variance–covariance equation, however, is not
modified. Any significantly positive Bij coefficient would docu-
ment the presence of positive volatility spillover from the mar-
ket such that increased market volatility would make time-
varying beta more volatile. The concerned industry might be
subject to additional risk when increased market volatility
makes asset return more sensitive to market movements.
This study examines whether the two types of betas,
namely, the domestic and global betas, are related to the
local and global market volatilities to explore all types of
volatility transmission channels and identify market risk of
investment at the industry level.
Finally, this study maintains that all volatilities may not rep-
resent a stressed situation. Investment risk might be magnified
if asset return's market sensitivities depend on market stress.
Any increase in market sensitivity (or, beta) with an increase in
stress would make the investment in the concerned asset riskier.
The equity market stress index and time-varying beta
The study constructs a stress index following the CMAX
method as follows:
   
 2015. Telecommunication betas fluctuate over time and, in
CMAX ¼ Xt =max X 2 Xt
j j ¼ 0; 1; . . . T ð5Þ
where Xt is the return from the concerned market (local or
global). The moving window is determined by T. Thus, CMAX
compares the current value of a variable with its maximum
value over the previous T periods. Vila (2000) used this
method to identify the periods of slide in the stock market.
The trigger level is considered at either 1.5 or 2 standard
deviations below the mean of the series.
This study selects four window periods, namely, 15, 30,
45 and 60, to define stress. Hence, it compares the current
return from the market in proportion to the maximum return
over the previous 15, 30, 45 or 60 days. A market is in stress
if the index value is less than 2 standard deviations below
the average return for that market. A trigger price is thus
defined as the average market return less than 2 standard
deviations of the market return.
The stress index then takes the value 1 (or the market is
in stress) if CMAX<Trigger Price; and 0 otherwise.
To confirm whether time-varying betas relate to market
stress, we estimate a suitable GARCH model as the one in 2
(a) and 2(b). The mean equation considers time-varying
betas as dependent on the relevant market stress.
Results and discussion
Case for India
Table 1 reports the constant CAPM betas for six Indian indus-
tries. Healthcare and IT have insignificant betas. The
G. Chakrabarti, R. Das
Table 1 Constant CAPM beta for Indian sectors.
Industry Domestic Covariance
market beta proportion
Bank 1.17* 0.25
Automobile 0.86* 0.19
Industrial sector 0.10* 0.13
Telecommunication 0.05** 0.12
IT 0.02 0.11
Healthcare 0.01 0.05
*
and ** imply significance at 1% and 5% level, respectively.
banking sector emerges as the only aggressive sector, while
the others remain defensive. The covariance proportions of
the mean squared forecast errors are found to be low for all
cases, indicating the inefficiency of a constant beta CAPM.
We identified the phases considering the trends in price
movements in each industry separately and calculated the
constant CAPM beta for each phase (Table 2). The results
suggest that beta changes over different phases of market
movements. Healthcare, for example, shows an insignificant
beta for the entire period on the basis of a constant CAPM,
while its betas varied significantly over the phases of price
movements observed for the sector and remained significant
in each phase, except for the first phase, similar to the IT
sector. In some phases, it even emerged a significantly
aggressive sector. The industrial sector with a very low over-
all beta became an aggressive sector, particularly after
many cases, assume significantly high values. The betas of
automobile sector also fluctuate over phases and often
assume values significantly higher than its constant beta.
The banking sector remains aggressive throughout the
period, except for the first two phases. However, in all
cases, the estimated betas are either higher or lower than
the constant beta.
The results obtained thus far are consistent with the lit-
erature (e.g., Berk et al., 1999; Jagannathan & Wang, 1996;
Lettau & Ludvigson, 2001; Gomes et al., 2003; Petkova &
Zhang, 2005) that highlights the inefficacy of constant beta
CAPM to capture the true market risk of assets as the betas
vary over different phases of price movement of the asset
concerned. The model's inefficiency in dynamic forecasting
further complicates the issue. Hence, while it is important
to make asset betas time dependent, estimating the con-
stant betas separately over different phases and their com-
parison would lead to further inefficiency. The method,
while suffering from the fundamental shortcomings of the
constant beta CAPM in each phase (including an error in
forecasting as evidenced by a lower covariance proportion
of the mean squared forecast error), might be sensitive to
how the phases are defined and is likely to be additionally
burdened by the loss of data in the process of such a phase-
wise estimation. An error in estimating the true market risk
of the asset concerned might thus be inevitable. The study
estimates a suitable MV GARCH model [as in 4(a) and 4(b)]
based on all 4551 data points to calculate the time-varying
betas for Indian industries. The movements in such betas
with their trends are shown in Fig. 1.
 Time-varying beta, volatility and stress
Table 2 Indian industry betas over different phases of industry–price movements

Industry beta Phases

1 2 3 4 5 6 7 8
Healthcare 1.2.99–24.1.00 25.1.00–2.4.03 3.4.03–17.6.08 18.6.08–17.3.09 18.3.08–27.3.14 28.3.14–31.1.17
0.11 0.58* 0.67* 0.41* 0.48* 0.74*
Covariance 0.03 0.1 0.12 0.09 0.10 0.13
proportion
Automobile 2.2.99–18.1.00 19.1.00–12.5.03 13.5.03–2.11.07 5.11.07–27.10.08 28.10.08–3.2.2014 4.2.2014–31.1.17
0.82* 0.58* 0.93* 0.65* 0.87* 1.07*
Covariance 0.25 0.17 0.27 0.17 0.24 0.28
proportion
Banking 2.1.02–10.12.02 11.12.02–14.6.06 15.6.06–14.1.08 15.1.08–9.3.09 12.3.09–10.1.14 13.1.14–31.1.17
0.67* 1.00* 1.15* 1.16* 1.23* 1.26*
Covariance 0.12 0.21 0.22 0.22 0.22 0.23
proportion
Tele communi- 19.9.05–9.6.06 12.1.06–9.1.08 10.1.08–12.3.09 13.3.09–18.9.09 22.9.09–1.6.10 2.6.10–10.8.12 13.8.12–10.7.15 13.7.15–31.1.15
cation 0.52* 0.08 0.88* 0.56* 0.01 0.67*
0.04 0.89*
Covariance 0.15 0.05 0.21 0.15 0.03 0.18 0.04 0.21
proportion
Industrials 19.9.05–7.1.08 8.1.08–9.3.09 12.3.09–9.11.10 10.11.10–21.8.13 22.8.13–26.2.15 27.2.15–12.2.16 15.2.16–31.1.17
0.19* 0.95* 0.59* 0.10** 0.33* 1.15* 1.23*
Covariance 0.07 0.25 0.18 0.05 0.11 0.27 0.29
proportion
IT 2.2.99–21.2.00 22.2.00–21.9.01 24.9.01–30.4.03 2.5.03–19.2.07 20.2.07–5.3.09 6.3.09–26.4.13 29.4.13–31.1.17
0.03 1.77* 1.73* 1.02* 0.83* 0.84* 0.61*
Covariance 0.03 0.31 0.32 0.22 0.19 0.19 0.14
proportion
*
and ** imply significance at 1% and 5% level, respectively.

55
56 G. Chakrabarti, R. Das

Fig. 1 Time-varying beta (Indian healthcare).

Fig. 3 Time-varying beta (an Indian bank)

The polynomial trend fitted to the data shows that
healthcare betas are mostly positive and dropping towards
the latter half of the study period. The actual range of betas
is between
0.12 and 0.20, which differs from the range of
0.11 to 0.74 obtained when constant betas were calculated
for different phases of healthcare sector price movements.
While the latter method overestimates the market risk of
the sector, it overlooks the possibilities of having negative
betas over some phases, implying a negative covariance
between the sectoral and market return. An observation of
the timeline shows such phases (e.g. 1999–2000, 2007, 2008–
2009) as periods of disturbances in the Indian market. Nega- Fig. 4 Time-varying beta (Indian industries).
tive healthcare betas for those periods and an overall low
beta range for the sector might establish it as a “safe” place
for investment. This issue is discussed further in the later
sections.
The automobile betas (Fig. 2) showed a rising trend after
the 2007–2008 financial meltdown. The industry faced rising
betas during the dot-com crisis, followed by a period of fall-
ing betas. The range of 0.35–1.46 obtained for the Indian
automobile time-varying beta differs from the range of
0.58–1.07 obtained, whereas constant betas were calculated
for different phases of automobile sector price movements. Fig. 5 Time-varying beta (Indian telecommunications).
The banking index, since its inception in 2002, has shown
a rising trend in its positive betas in the range of 0.28 to with market returns. Moreover, some of these phases of neg-
1.62. The constant CAPM beta calculated for different ative betas for both sectors are associated with the stock
phases ranges between 0.67 and 1.26, making the risk- market downturns. The presence of low or even negative
averse investor underestimate the maximum risk and over- betas, however, may be insufficient to consider these sectors
estimate the minimum risk (Fig. 3). as safe places for investment (see Figs. 4 and 5).
The polynomial trend fitted to the data shows that Indian Although the IT sector started aggressively, its beta
IT, telecommunication and industrial sector betas vary near declined after the 1999–2000 dot-com crisis and has
zero. Since their inception in 2005, industrial and telecom- remained low ever since. This result contradicts our study
munication indexes experienced falling betas, which then results while using constant CAPM beta for different periods
continued to move in low range. Betas increased during (Fig. 6).
2012–2013 and then fell, eventually becoming negative in The results bear significant implications for investment
2016. The industrial sector has relatively more phases of behaviour. Although the betas vary across phases and thus
negative betas when its returns were negatively associated the need to make them time varying, the use of constant

Fig. 2 Time-varying beta (Indian automobile) Fig. 6 Time-varying beta (Indian IT).
Time-varying beta, volatility and stress 57

Table 3 Indian industry betas under alternative methods of computation.

Industry Range of beta when Range of time- Implication for risk-

constant beta CAPM is varying beta (2) averse investor
used across phases (1)
Bank 0.67 to 1.23 0.28 to 1.62 Range wider in (2). (1) underestimates the
Automobile 0.58 to 1.07 0.35 to 1.46 (1) underestimates the risk and benefit
Telecommunication
0.04 to 0.89
0.40 to 1.03 aggressiveness
and defensiveness of the asset
Industrial sector 0.10 to 1.23
0.40 to 0.72 (1) overestimates the asset's (1) overestimates
Healthcare 0.11 to 0.74
0.12 to 0.20 aggressiveness and u market risk
nderestimates its defensiveness
IT 0.03 to 1.77 0.03 to 1.30 Range shorter under (2).
(1) overestimates the
aggressiveness of the asset

CAPM betas for the different phases fails to capture the true
market sensitivity of Indian industries (Table 3). Market sen-
sitivities are either overestimated or underestimated with
serious implications for investors who seek to minimise the
non-diversifiable risk on their investment. The market risks
and benefits of investing in the banking, automobile and
telecommunication sectors are underestimated, whereas
the risks for industrial, healthcare and IT sectors are overes-
timated. Hence, deciding on the basis of time-varying beta
affects the choice of sectors for possible investment.
The values of beta, however, may be related to the move-
ments in the relevant markets or the sector. Sectoral betas
that are closely related to the movements in the underlying
sector would signify cyclicality so that market risks may be
predicted to remain at a particular level during upturns or
downturns of the sectors. This might add further risks to
investment decisions, for example, in cases where market
risk increases during downturns.
A consistently lower beta may not be adequate to imply a
lower risk if the betas show greater volatility in a volatile
market. To explore the possible presence of such idiosyn-
cratic risks, this study relates time-varying betas to market
movements.
To resolve these issues, the study examines a possible vol-
atility transmission channel from the sector to its time-vary-
ing beta. Any affirmative answer would establish cyclicality
in the time-varying beta. Second, it explores whether vola-
tility in domestic and/or global market spills over to the
time-varying betas and the influence that stress in the rele-
vant markets has on the time-varying betas. The possible
presence of volatility spillover from markets is explored by
estimating two separate bivariate GARCH models as spelt
out in Eq. (3).
Table 4 reports the coefficients of estimated Bij from the
three models.
The study finds no transmission channel from which vola-
tility in a particular sector may be transmitted to its time-
varying beta.
The Indian sectoral betas, however, receive significant
volatility spillover from the domestic and global markets,
with the extent of spillover being stronger from the former.
Within the sectors, spillover from the domestic market has
been stronger for the healthcare and IT sectors, followed by
that for the telecommunication, banking, and automobile
sectors. The IT and telecommunication sector betas, how-
ever, receive the strongest spillover from the global market,
followed by healthcare, banking, and automobile.
A volatile market leads to fluctuation of the market sensi-
tivity of assets, thereby increasing the risk of investment.
This study, however, maintains that a volatile market does
not always indicate market stress. While volatility is mere
fluctuations in returns, stress may be defined as a situation

Table 4 Volatility spillover from domestic and global markets to Indian time-varying beta.

Industry Bij (coefficient showing Bij (coefficient showing Bij (coefficient showing
volatility spillover volatility spillover from volatility spillover
from global market) domestic market) from sector)
Healthcare 0.38* 0.98* 0.14
Transportation 0.22* 0.90* 0.07
Banks 0.29* 0.93* 0.08
Telecommunication 0.42* 0.96* 0.03
Industrials 0.37* 0.93* 0.10
Information technology 0.42* 0.98* 0.10
*
and ** imply significance at 1% and 5% levels, respectively.
58 G. Chakrabarti, R. Das

where market returns fall significantly below some floor set

(60 days, 2SD)

by its historical average. Although investors find it difficult

0.0027*
to design hedging strategies in situations of stress, the risk

0.0005
0.0003

0.0020

0.0003

0.0023

0.0004
0.0030

0.0031

0.0018

0.0020
0.0000
of investment would further increase when the sensitivity of
asset returns to market movements is affected (or, particu-
larly, increases) in situations of market stress because in a
stressed situation, market moves downwards, and with an

(60 days, 1.5SD)

associated increasing beta, asset returns would continue to
respond to such falls by falling more than proportionately.

0.0029*
Table 5 shows how the local and global market stress affect

0.0007
0.0003

0.0024

0.0001

0.0026

0.0001
0.0000
0.0034

0.0018

0.0020

0.004*
Indian sectoral time-varying betas.
The Indian healthcare sector with an insignificant con-
stant CAPM beta faced significant market risks when the
movement of the beta over different phases of its price

(45 days, 2SD)

movements was considered. The volatility in the local and

0.0045*
0.0027*

0.0025*
global markets significantly spills over to raise its market

0.0006
0.0002

0.0024
0.0000

0.0022
0.0031

0.0024

0.0001

0.0002
sensitivity. Stress in the domestic market has a significant
positive impact on healthcare beta, at least during the 15-
and 30-day window. Hence, for healthcare sector, the
domestic market stress is considered significant. However,

(45 days, 1.5SD)

the global market stress does not affect both healthcare and
IT sectors. Telecommunication beta showed an erratic move-

0.0045*
0.0027*

0.0025*
ment over the different phases of its price movement.

0.0006
0.0002

0.0024

0.0002
0.0036

0.0024

0.0023

0.0001

0.0002
Although there are significant volatility spillovers from the
domestic and global markets to its time-varying beta, no
market stress affects such betas. The industrial and tele-
communication sectors are safe, however, with different
(30 days, 2SD)

characteristics. The telecommunication beta is not affected

by any market stress, whereas the industrial sector betas,
0.0013*

0.0027*

0.0024*
0.0011*

0.0003

0.0024
0.0031

0.0012

0.0028

0.0002
0.0019

0.0002
which are unaffected by domestic market stress, drop when
the global market is under stress. The automobile sector
betas behave similarly to those for the industrial sector.
However, the effect of the global market stress is more
(30 days, 1.5SD)

prominent on the industrial sector. The banking sector

Indian time-varying beta and domestic (D) and global (G) market stress.

remains risky because regardless of how stress is defined for

domestic market, such stresses always affect its betas.
0.0013*

0.0027*

0.0023*
0.0010*

0.0002
0.0031

0.0038

0.0022

0.0002
0.0026

0.0021

0.0002
Hence, for the Indian market, healthcare, banking and IT
sectors are subject to higher market risks as their time-vary-
ing betas increase significantly when the Indian market
sharply declines. Such sectoral betas are seldom related to
(15 days, 2SD)

global market risks, but whenever they do the phenomenon

favours the investors.
0.0026*

0.0010*
0.0006
0.0002
0.0027
0.0007

0.0030

0.0003
0.0021

0.0021

0.0023

0.0002

The results obtained for an emerging market, namely,

India, are compared with those obtained for the financially
developed market, such as the United States.
(15 days, 1.5SD)

Case for the United States

0.0013*

0.0029*

0.0025*
0.0010*
0.0002
0.0029
0.0002

0.0028

0.0001
0.0022

0.0022

0.0002

Table 6 shows the constant CAPM beta obtained for the six
US industries. While all betas are significantly positive at the
implies significance at 1% level.

1% level of significance, the IT sector has the highest value

of beta, followed by the telecommunication sector. These
two sectors, however, behave almost like the market, as is
Telecommunication (G)
Telecommunication (D)

evident from their beta values that remain close to 1. The

banking sector exhibits minimum market sensitivity. This is
Automobile (G)
Automobile (D)

in sharp contrast with the results obtained for the Indian

Healthcare (G)
Healthcare (D)

Industrials (G)
Industrials (D)

market.
Banks (G)
Banks (D)

Table 7 shows the movements in the US sectoral betas

Table 5

over the respective phases of their price movements. The

IT (G)
IT (D)

phases are identified considering the trends in the sectoral

*

index movements. For all sectors, the betas vary

Time-varying beta, volatility and stress 59

Table 6 Constant CAPM beta for the US sectors. respectively, with the assumption that a constant CAPM beta
would not be able to capture the true market sensitivity of
Industry Domestic Covariance the sectors.
market beta proportion The time-varying betas for the US sectors estimated using
Bank 0.44* 0.11 a suitable bivariate GARCH model, as shown in 4(a) and 4(b),
Transportation 0.65* 0.14 are shown in Figs. 7 to 12.
Industrial sector 0.82* 0.15 The US time-varying beta shows a declining trend (Fig. 7)
Telecommunication 0.98* 0.13 before the 2007–2008 global meltdown. It then shows a rising
IT 1.08* 0.14 trend until December 2015 and declines again. For a compa-
Healthcare 0.78* 0.14 rable period, a similar trend was observed for the Indian
* ** healthcare sector. The time-varying beta for the US trans-
/ implies significance at 1%/5% level.
portation sector declined during the dot-com crisis of 1999–
2000 (Fig. 8). It increased steadily thereafter until the finan-
cial meltdown of 2008, followed by a mild downward trend.
significantly over the phases and for some sectors, such vari- The Indian automobile sector beta, on the other hand, has
ation is quite significant. For example, the betas of health- shown greater variation with an increasing trend recently.
care sector with a constant CAPM beta 0.78 vary in the range The US banking sector shows a rising trend in beta from
of 0.68 to 1.10, with an average beta of 0.84. The transpor- 1999 to 2009 and starts declining thereafter (Fig. 9). How-
tation sector beta varies in the range of 0.37 to 1.06, with ever, there has been a recent increasing trend. The Indian
an average of 0.78. The constant CAPM, however, underesti- banking sector beta demonstrates a continuously rising
mates its beta at 0.65. The average beta of the banking sec- trend throughout the study period.
tor over phases is 0.60, which is much higher than its The US telecommunication beta shows a mild rising trend
constant CAPM value of 0.44. For sectors such as telecommu- until the financial meltdown of 2007–2008 (Fig. 10). It then
nication, IT and industrial sector, the constant CAPM beta is falls until 2015 and demonstrates a rising trend thereafter.
more than the average beta for the sectors over the phases. The trends are almost similar to those followed by its Indian
Similar to the results obtained for the Indian sectors, the counterpart, with the only exception that the betas of the
average betas over the phases are 0.95, 1.01 and 0.79, latter remained close to zero.

Table 7 The US industry betas over different phases of industry–price movements

Industry beta Phases

1 2 3 4 5 6
Healthcare 14.7.05–12.5-08 13.5.08–27.2.09 28.2.09–14.7.15 14.7.15–31.1.17
0.68* 0.74* 0.85* 1.10*
Covariance 0.15 0.17 0.19 0.21
proportion
Transportation 4.1.99–12.07.07 13.7.07–2.3.09 3.3.09–4.6.14 5.6.14–24.8.15 25.8.15–31.1.17
0.37* 1.06* 0.97* 0.82* 0.70*
Covariance 0.18 0.29 0.27 0.21 0.20
proportion
Banking 4.1.99–21.6.01 24.6.01–20.1.04 21.1.04–15.1.08 16.1.08–1.9.09 2.9.09–8.8.11 9.8.11–31.1.17
0.18* 0.20* 0.51* 0.92* 0.99* 0.77*
Covariance 0.11 0.11 0.15 0.18 0.18 0.16
proportion
Tele communi- 4.1.99–3.3.00 4.3.00–15.2.02 16.2.02–7.10.08 8.10.08–30.12.08 30.12.08–31.1.17
cation 0.82* 0.86* 0.98* 1.10* 1.00*
Covariance 0.18 0.18 0.19 0.21 0.21
proportion
Industrials 4.1.99–3.3.00 4.3.00–23.7.02 24.7.02–30.5.07 31.5.07–19.11.08 20.11.08–31.1.17
0.63* 0.66* 0.81* 0.92* 0.95*
Covariance 0.15 0.15 0.17 0.17 0.17
proportion
IT 4.1.99–9.3.00 10.3.00–22.7.02 23.7.02–8.10.07 9.10.07–12.11.08 13.11.08–6.7.12 7.7.12–31.1.17
0.97* 0.98 1.00* 1.00* 1.06* 1.04*
Covariance 0.21 0.22 0.24 0.24 0.26 0.26
proportion
*
and ** imply significance at the 1% and 5% levels.
60
Fig. 7 Time-varying beta (US healthcare).
Fig. 8 Time-varying beta (US transportation)
Fig. 9 Time-varying beta (US banks)
Fig. 10 Time-varying beta (US telecommunication).
The US industrial sector beta showed a rising trend until
2012 and then fell to rise again since latter half of 2016
(Fig. 11). Such trends differ from those demonstrated by its
Indian counterpart.
Finally, the US IT sector beta is consistently close to the
value of 1 (Fig. 12). This is in sharp contrast to the Indian IT
sector beta movements that remained consistently close to
zero.
Table 8 justifies the use of time-varying beta rather than
using constant beta CAPM across the phases of sectoral price
movements. In all cases, the latter underestimates the mar-
ket risk of the industry concerned as it underestimates the
maximum value of beta. Concurrently, it underestimates the
benefit as it overestimates the minimum value that the
G. Chakrabarti, R. Das
Fig. 11 Time-varying beta (US Industrial)
Fig. 12 Time-varying beta (US IT)
concerned beta might take. For the banking, transportation
(automobile in context of India) and telecommunication sec-
tors, the results are identical.
The extent of volatility spillover from the sector, the
domestic and global markets to the time-varying beta for
the US industries is shown in Table 9. This table reports the
Bij coefficients when the relationship between the US time-
varying beta and relevant market's conditional variance
of return are modelled using a suitable model as is given by
Eq. (3).
No significant volatility spillover is found from the sectors
or global market to US sectoral betas. Volatility in the
domestic market, however, significantly spills over to such
betas. The extent of the domestic market volatility spillover
is maximum for the IT sector beta and minimum for the
healthcare beta.
Table 10 shows how the stress in domestic and global mar-
kets affects the US time-varying betas. The results differ
from those obtained for the Indian market. Time-varying
betas for industries such as healthcare, transportation,
banking and industrial sectors are significantly negatively
related to domestic market stress. Hence, an increase in
domestic market stress leads to a fall in beta. The extent of
drop in asset returns following a slide in market would con-
tinue to decline, thereby reducing the risk of investment.
The telecommunication and IT sector betas, however,
remain completely dissociated with domestic and global
market stress.
Conclusion
While exploring the time-varying nature of beta in India and
the United States, this study found the inefficacy of the con-
stant beta CAPM to identify the true nature of market sensi-
tivity of different sectors. Moreover, the use of such a model
Time-varying beta, volatility and stress 61

Table 8 US industry betas under alternative methods of computation

Industry Range of beta when Range of time- Implication for risk-

Constant beta CAPM varying beta (2) averse investor
is used across phases (1)
Banking 0.18 to 0.99 0.01 to 1.52 Range wider in (2). (1) underestimates risk
Transportation 0.37 to 1.06 0.03 to 1.49 (1) underestimates and benefit (same as in India)
Telecommunication 0.82 to 1.10 0.53 to 1.30 the aggressiveness and
Industrial sector 0.63 to 0.95 0.51 to 1.15 defensiveness of the asset (1) underestimates risk
Healthcare 0.68 to 1.10 0.38 to 1.44 and benefit
IT 0.97 to 1.06 0.81 to 1.18

Table 9 Volatility spillover from domestic and global markets to US time-varying beta

Industry Bij (coefficient showing Bij (coefficient showing Bij (coefficient

volatility spillover from volatility spillover showing volatility
global market) from domestic market) spillover from sector)
Healthcare
0.04 0.91* 0.03
Transportation
0.11 0.93*
0.09
Banks
0.08 0.93* 0.04
Telecommunication 0.04 0.93* 0.02
Industrials 0.02 0.93* 0.12
Information Technology
0.11 0.95*
0.08
*
and ** imply significance at the 1% and 5% level, respectively.

separately for different phases of the sectoral price move-
ment and a comparison of betas thus obtained failed to cap-
ture the true dynamics of beta movement. This remains true
irrespective of the level of financial development of the
countries considered, although with some differences in the
nature of the problem. In an emerging and financially less-
developed country such as India, the use of such a method
leads to an overestimation of market risk for sectors such as
healthcare, industrial sector, and IT. It, however, underesti-
mates the risks and benefits of investing in banking, automo-
bile, and telecommunication sectors. In the US market, in
contrast, this method leads to an underestimation of the
risk and benefit for all sectors. Quantitative techniques such
as the iterative cumulative sum of squares (ICSS) test intro-
duced by Inclan and Tiao (1994) used in identifying the
phases endogenously might be unsuitable because the prob-
lems associated with constant beta CAPM would persist even
when used in phases separately. The study thus calculates
the time-varying beta for the two countries and relates
those to market volatility and particularly to market stress.
All Indian sector betas face a significant volatility spill-
over from the domestic market and a relatively mild trans-
mission from the global market. The upheavals at the
sectoral levels, however, cannot affect the time-varying
betas. Of the chosen sectors, such a spillover greatly affects
the IT beta. The impact on the banking and automobile sec-
tor betas has been less pronounced. While all betas face
spillover from markets, they behave differently under mar-
ket stress. Telecommunication sector betas are not affected
by any market stress, whereas the automobile and industrial
betas that are independent of stress in the domestic market
decline under global market stress. IT and healthcare betas
increase significantly under domestic market stress. Hence,
within India, telecommunication, automobile and industrial
betas might attract investors who seek to minimise the mar-
ket risk of investment. For the US market, IT and healthcare
betas are the worst affected by domestic market volatility
spillover. Global market volatility, however, does not spill
over to any of the betas. The US IT and telecommunication
betas remain completely dissociated from domestic market
stress. The betas for the other sectors fall when the domes-
tic market is under stress. The sectoral upheavals do not
affect the US time-varying betas.
The results bear significant implications for investors who
seek to minimise the market risk of investment. These per-
haps modify the endemic concern that time-variant beta
adds to the risk of investment. Such time-varying sectoral
betas in India and the United States face significant volatility
transmission from their respective domestic markets. The
emerging market sectoral betas face volatility spillover
from global markets, but their developed market counter-
parts are not susceptible to these spillovers. The developed
market betas can avoid market stress or even collapse,
thereby making the asset under consideration less risky. This
is often true for the emerging market betas, but there are
cases where such betas increase under stress. This is particu-
larly true for the Indian IT sector. Hence, making betas time
variant does not always lead to additional market risk for
investors and might help in hedging. However, concerns per-
sist about the emerging market.
62 G. Chakrabarti, R. Das

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0.0029*

0.0039*

0.0046*

0.0042*

0.0029*

0.0023*

0.0009

0.0030
0.0010
0.0021

0.0004

0.0002

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0.0039*

0.0043*

0.0052*

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0.0025*

0.0005

0.0028
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0.0022

0.0003

0.0002

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*
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