A conditional regime switching CAPM

Vasco Vendrame, Cherif Guermat, Jon Tucker

Research output: Contribution to journalArticlepeer-review

13 Citations (Scopus)
89 Downloads (Pure)


The standard Capital Asset Pricing Model (CAPM) is simple, intuitive, and grounded in sound economic theory. Yet, almost half a century's worth of empirical testing has so far failed to demonstrate its relevance. One major reason given for the CAPM's empirical failure is that beta is not the sole measure of systematic risk. In other words, the standard CAPM does not hold. Another important explanation is that the CAPM may hold conditionally rather than unconditionally. The standard CAPM fails to explain the cross-section of returns because it ignores the fact that both the risk and the price of risk are time-varying. The search for conditional models has led researchers to either disregard the theory behind the CAPM or to use statistical procedures that are too complex to be replicated by other researchers and practitioners. In this paper we propose a conditional model that is compatible with the standard CAPM while remaining simple and accessible to both researchers and practitioners. Beta and the risk premium are assumed to be time-varying, with the latter being associated with bull and bear states. We find strong support for the conditional CAPM with beta explaining both bull and bear markets. While the bear market ex-post risk premium is negative, the weighted average risk premium is positive and highly significant.

Original languageEnglish
Pages (from-to)1-11
Number of pages11
JournalInternational Review of Financial Analysis
Early online date12 Dec 2017
Publication statusPublished - 1 Mar 2018
Externally publishedYes

Bibliographical note

NOTICE: this is the author’s version of a work that was accepted for publication in International Review of Financial Analysis. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in International Review of Financial Analysis, Vol 56, 2018 DOI: 10.1016/j.irfa.2017.12.001

© 2017, Elsevier. Licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International http://creativecommons.org/licenses/by-nc-nd/4.0/


  • Asset pricing
  • Bear market
  • Bull market
  • Conditional CAPM
  • Regime-switching

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics


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