The Conditional Beta and the Cross‐Section of Expected Returns

We examine the cross‐sectional relation between conditional betas and expected stock returns for a sample period of July 1963 to December 2004. Our portfolio‐level analyses and the firm‐level cross‐sectional regressions indicate a positive, significant relation between conditional betas and the cross‐section of expected returns. The average return difference between high‐ and low‐beta portfolios ranges between 0.89% and 1.01% per month, depending on the time‐varying specification of conditional beta. After controlling for size, book‐to‐market, liquidity, and momentum, the positive relation between market beta and expected returns remains economically and statistically significant.