Capital Asset Pricing Model and Changes in Volatility

Abstract

This article applies regime-switching models to assess the effects of different regimes of volatility in asset pricing. Different variance-covariance matrices for different regimes of volatility are introduced in the Capital Asset Pricing Model. They are scaled with respect to a conditional variance-covariance matrix that simply follows a GARCH process. The probabilities that U.S. financial markets were in a low, medium, or high regime of volatility from March 1958 to December 1995 are computed.Creation-Date : 1998-09