Bad beta, good beta and stochastic volatility in an inter-temporal asset pricing model for the Kenyan stock market

Abstract

The study seeks to investigate whether bad beta (sensitivity to cash-ow news), good beta (sensitivity to discount rate news) and volatility news are significantly priced in the Kenyan stock market. A comparison of the 3 models is done: 2-beta pricing model (with cash-ow news and discount rate news as risk factors), a 3- beta model (including volatility news) and a 4-beta model (including covariation risk in cash-ow and discount rate news). The findings from the study suggest that news terms related to cash flows, discount rates, volatility and the covariation of cash-ow news and discount rate news are all significantly priced in the Kenyan Market. There is evidence that Kenyan investors are highly risk averse, more so towards cash-ow news, than they are to discount rate news. Similarly, the premium charged for volatility news is just as high as that attached to cash flow news. Investors also attach a significant but relatively smaller premium to the risk due to covariation between cash-ow news and discount rate news.