Beta Forecasting at Long Horizons

Systematic (CAPM beta) risk forecasting for long horizons, such as one year, plays an important role in financial management. This paper evaluates a variety of beta forecasting procedures for long forecast horizons. The widely utilized Fama-MacBeth constant beta approach based on five years of monthly returns is found to be unreliable in terms of the mean absolute (and squared) forecast error and statistical bias. The most accurate forecasts are found to be those generated from an autoregressive model of the realized beta. In addition to analyzing the statistical properties of these forecasts, this paper demonstrates the economic significance of the different approaches through an evaluation of investment projects.