Title: Learning about beta
Description: "When risk-factor loadings are time-varying and unobservable, investors are forced to form beliefs about the levels of their loadings.  The learning process involved in forming these beliefs has normative implications for asset-pricing tests.  This paper develops an equilibrium model of learning about time-varying beta.  In the model, the capital asset pricing model (CAPM) works for investors' probability distribution.  However, mis-pricing can be observed if econometricians estimate betas without accounting for the investors' learning process.  The empirical implication for asset-pricing tests is that the factor loadings must be estimated as latent variables.  We provide an empirical application of this methodology to the cross section of returns on ten book-to-market and ten size-sorted portfolios.  For these assets, the data do not reject a learning-augmented version of CAPM.  This model performs better than other common empirical specifications, including the Fama-French three-factor model"--Federal Reserve Bank of New York web site.
Subjects: Capital assets pricing model, Investments, Mathematical models, Prices, Psychological aspects of Investments, Stocks