Journal of Fmanclal Economtcs 5 (1977) 309-327 P North-Holland Publlshmg Company

ESTlhlATINC BETAS FROhI NON!3 NCHRONOUS DATA

hiyron SCHOLES and Joseph WILLlAhIS*

LSlirersrrr of Chcugo Chcugn IL 60637, Lf S 4

Recened Noiember 1976 Ic\lsed \erslon reccl\ed October 1977

Nons)nchronous trading of securmcb Introduces Into the market model a porentiallv serious
econometric problem of ct rors In \arrahles In thlb paper propertles of the obberved market
model and a>soclated oldlnar\ least squares estimators are developed tn detail In addltlon.
compulatlonally cometvent, consrqtent estimators tor parame’ers of the marhet model are
calculated and then applied to dad} returns of securltleb Il,ted In the NYSE and ASE

1. Iohoductioo

Central to contemporary theory In finance IS the fundamental concept of

systematic rrsl\ or beta for a security Not surprlslngly, much current empu-ical
\\ork rn finance focuses on the associated problem of estlmatlng this systematic
risk or beta Although to date almost all estimates have used monthly returns
on common stochs, recently daily returns hake become a\allable’ With this
new data more pobierful empirical tests are now possible
Unfortunately, the use of daily data introduces Into the market model a
potentially serious econometric problem In particular, manq securities hsted
on organized exchanges are traded only infrequently, with fei! securities so
actively traded that prxes are recorded almost continuously ’ Because prices
for most securltres are reported onI> at dlbtinct random intervals, completely
accurate calculation of returns o\er any lived sequence of periods IS wrtually
rmposslble In turn this Introduces Into the market model the econometric
problem of errors in \nrlables With daily dat.1 thib problem appears partlcu-
larly severe

*Ue thanh hlrchxl Jensen and the reieree, G WIllram Schitert, for comment> on a pre\wus
draft, MarbIn Llpson for programmmg assl,tdnce and the Center for Rewarch In Security
Prices, Utwersit> of ChIcago for iindnclal support
‘Da~l) dota for total returns on approwmatelq WOO AecuI’t~cs Insted on the Ne\\ \ orb and
-2mericnn \rock Exchange5 betiteen Julk 2 1961 and December 31, 1975 hale been collected at
thecenter for Research rn Securrlr Prices Graduate School of Bwnesh Unt\erslr\ 01 Chicago
2Fama (1965) and rl>her (19661 first reco_enlzed the nonfradlng ofsecurrucs a> I potentlJllj
serious empirical problem Some of the results In this paper appear In a xt 01 unpuhll\hed notes
bv Oldrrch L’aslchch, Graduate School of hlanagcmenr. Unl\ersrt) of Rochebrsr R&l4
results appear m Cohen, hlaler, Schwarlz, and Whltcomb f 1977)
310 M Scholes and J Wdhams, Estrmatrng betas

In sectlon 2 of this paper, properties ofthe market model wth nonsynchronous

data are developed In detail Assuming that true Instantaneous returns on
securities are normally distributed, It IS shoi\ n that variances and co\ wances
of reported returns differ from corresponding variances and co\arrances of true
returns Under plausible restrrctlons on trading processes, measured karlances
for single securities overstate true variances, while measured contemporaneous
covarlances understate In absolute magnitude true co\arlances Also, reported
returns on single securltles appear serially correlated and leptokurtlc relative
to actual returns AddItIonal properties for measured returns on portfohos of
securlt:es are reported
With errors In variables In the market model, ordinary least squares estimators
of both alphas and betas for almost all securltles are biased and inconsistent
In this part:cular problem wvlth errors from nonsynchronous trading of securltles,
there lemalns wrthrn reported returns sufficient structure to Identrfy both the
direction and magmtude of any asymptotic bias Accordingly, In section 3 rt IS
shown that securities trading on average either bery frequently or very Infre-
quently have ordinary least squares estrmators asymptotically brased upiiard
for alphss and downiiard for betas By contrast, for those remaining securities
wth more akeragc trading frequencies, least squares estunators of alphas and
betas are asymptotically blased In the opposite dlrectlons
In section 3 computationally convenient, consistent estimators for coefficients
in the market model are constructed The consistent estimator for beta IS calcu-
lated as a comblnatlon of ordinary least squares estimators Specifically, the
sum of betas estimated by regressing the return on the security against returns
on the market from the prevrous, current, and subsequent periods IS dwlded by
one plus twice the estimated autocorrelatron coefficient for the market Index
In turn these consrstent estimators of alpha and beta are shoirn to be equivalent
to Instrumental variables estimators which use as an instrument the moving sum
of measured rates of return on the ma&et for the preblous, current, and sub-
sequent periods In addition, asymptotic standard errors for these estimators
are calculated
In section 5 the consistent estimators are applied to dally returns from
securities llsted on the New York and American Stock Exchanges between
January, 1963 and December, 1975 Estimates of alphas and betas are calculated
and then compared to the corresponding ordinary least squares estimates for
portfolios comprised of securltles selected by trading volume Almost \\lthout
exception, these estimates are consistent 111th the predlctlons from section 3
All basic results cited In the text are dewed III the appendix

2. The problem

Implwt behlnd the basic capital asset prwng model rn contmuous time IS the
assumption that all risky securltles have prices distributed as mfinrtely dlvwble,
 M Scholes and J Wdbams. Esrrmatrng betas 311

lognormal random vanables 3 With thrs assumption the continuously com-

pounded returns r,,, on risky securltres tz = 1. A’, as calculated over any
Intervals [t-l, I]. t = I, , T, are Joint normally dlstrlbuted NII~ the constant
means jl,, constant variances a,Z, and constant covarlances on,,,, r~ # tw,
?l.rn = 1, , Y In turn this ImplIes that the corresponding rates of return
;~;swa;L;;lnL; on the market Index .\I are normally distributed wth the
2
,,,, constant \sri,Ince o,,, and constant covarrances on%,,
)I = 1, , N Here lnll represents the constant percentage iteIght of security n
m the market Index ,I1 Collectl\ely. these assumptions Imply the simple market
model

t nr - %+PnfIlt+L, (1)

i\here an = /r,,-,!I~f,~ and ,!?, = G..,~,‘c& are the constcnt coeffiwnts alpha and
beta The residual E,,,, ortho:opal to rS,,,, IS normally distributed \\lth a zero
mean plus constant variances and covarrances
In practice, however. the marhet model (I) IS not continuously observable
Because most securltlcs trade at discrete, stochsstrc Inter\als in time, \\cth prices
recorded only at points of actual trades, (I) cannot be observed at all times
0 S t 5 T This dlscontlnuous trading of seculitles Introduces into the market
model the common econometrrc problem of errors In variables
Specrfically. consider any sequence of distrnct, uniformly spaced points in
time t = 1, T 111th the corresponding Intervals [t- 1. t] During any such
Inter\al there dccurs either no trade, no observed price, and hence no calculated
return, or, alternatlkely, at some random time t-s,,, 0 2 s,, 5 1, a last trade
and consequently a reported closing price Here s,,, represents the residual
portion of trading perrod t during which no trades in securny /I occur If over
any two consecutive Interlals closing prices are reported, then a rate of return
ri, can be calculated for the corresponding perrod [t- 1 -s,,,-, , t-s,,] (See
figure 1 ) Collectmg all such measured rates of return, and ignoring periods over
which no trades occur, generates rhe sampling sequence {ril} dlffermg rn general
from {r,,} 4 In turn this lmphes for the market Index a measured sequence
{&} of returns, I trc s IF=, r,ftvndf, also dlfferlng from (r,w,} 5 Errors In
variables result when measured returns are used as proxies for true unobservable
returns

3For a dlscusslon of this prlcmg process see Merton (1973) More generally, the results of
this paper requrre only that the prlclng process he mfimtely dnwble wth Independent rncre-
ments Thrs permrts, for example, compound Powon processes
4All mformatlon about returns over daqs In which no trades occur IS Ignored This greatlq
srmphfies thesubsequent estimators
‘Some varlablhty over time m the market mdev IS Introduced by evcludmg from the Index
secunties not trading durmg the particular period Presumably, these effects are rnmor Varl-
ability rn the market index has no effect on the results of sectlon 2 nor on the maJor results (16)
and (17)
 M Scholes and J W~lhams. Estrmarmg betas

t-1

, %ll+l

1*1-S,,+,

True
Returns

Iecurlly 0
I
I

r In,.,

t-1 t t*1
FIN 1 Measured returns versus true returns for securltles II and IPI over periods t and I+ 1

With these presumably unavoidable errors rn variables, measured returns are

no longer generated by a slmplc Gauwan process Instead, measured returns
awe from a subordinated process \\lth parameters dependent upon reahzatlons
of the drrectlng process determIning actual times bet\\een trades In terms of the
market model (I), this subordlnatlon rmphes

r;, = cc:,+ /Q ;,, + E:, , (2)

wrth the coefficients

(3)
 M Scholes and J Wtllrams. Esrrmarrtrg betas 313

and

(4)

Generally (3) and (4) differ from the corresponding coefficients CI,and P,, In (I)
Agam the residual E;, has a zero mean and zero covarlance \slth the regressor
r&, In (2) no restrlctrons are placed on the sequence of nontradmg periods
IS,>, S, = (S,,, 7%I)
All differences between the observed market model (2) and the true model (I)
reflect differences between measured returns and true returns In general, with
errors of obsenatron, measured returns deviate from normahty wth moments
dependmg on properties of both true returns and nontradmg periods Means,
variances, and covarlances for measured returns are dewed rn the appendix,
part (I) In the plausible special case with all nontradrng periods S, Independently
and ldentlcally dlstrrbuted ober trme, these moments simplify as follons

%,‘,I = ib,. (5)

var(ri,) = {I +2var(s,)/oi}oi, (6)

with the coefficient of variation u, = CJ,/P,,,

cov(r;,, rz,) = {I -E[max(s,, s,}-mm {s., s,)]

+ 2 cov (% 7%JIP”,~“~, hm - (7)

wth the correlation coefficrent pnrn E u,,,/~,,cT,,,,

cov(ri,, ri,._,) = - {var(s,)/oi}at, (8)

and
CO\’(I-.‘,, r&_,) = {E[max is,--s,, O)]

+ cov (%I9~“)IP”rnwn bnm (9)

In this special case all remamlng covarlances of various lags disappear

The properties of (5) through (9) are mterestlng With nontradmg periods S,
distributed Independently and rdentlcally over time, expectations of measured
returns (5) for single securrtles always equal true mean returns By contrast, for
srngle securities, measured variances (6) overstate true vanances, while measured
autocovarlances(8)oflagone appear negatwe Also, measured contemporaneous
covariances (7) differ from true covarlances, while measured covarlances (9) of
lag one deviate from zero Finally, all remamlng covarlances for lags greater
than one vanish in the absence of data from periods durrng whrch no tradmg
occurs
314 A4 &Roles and J Wtlhams. Eshnatrng betas

With dally data addItIonal slmphficatlons In (6) through (9) are possible.
Specifically, for dally returns on NYSE and ASE common stocks, the co-
e&tent of varlatlon u,,exhlbrts an average value roughly rn the range of 30 to 40.
This Implies that for single securrtles measured variances (6) closely approxl-
mate true variances while measured autocovarlances (8) closely approximate
zero In addition, for single securltres measured contemporaneous covarlances
(7) understate in absolute magnitude true covanances, while measured co-
variances (9) of lag one share l\lth true contemporaneous covarlances the same
sign but a smaller absolute value Moreover, the magnitudes of these effects
on covariances are greater for securities trading on average less frequently
More precisely, m (7) the discrepancy of measured contemporaneous covarlances
from true covarlances IS greatest when one security trades on average very
frequently while the remaining security tlades very Infrequently Slmllarly, In
(9) the discrepancy IS greatest when security II trades very frequently while
security rn trades very lrlfrequently 6
In turn these properties have Imphcations for dally returns from large
portfolios Suppose that In practice returns on lndwdual securities are pre-
dommaotly posrtwely correlated Also recall that for large portfolios variances
are primarily determined by the covarlances of returns among component
securities From (6) and (8) this implies that measured variances for dally
returns on large portfohos typically understate true variances For portfolios
more heavily weighted with securities trading on average less frequently - e g ,
an equally weighted portfolio - these effects are even more pronounced Clearly,
both these properties contrast sharply l\lth the corresponding results for single
securities
For rndwdual securities reported returns deviate from normality This
deviation IS measured In part by the kurtosls of reported returns Assuming
as before that the nontradmg periods S, are Independently and ldentlcally
drstrrbuted over time, the kurtosls ~(ri,) of measured returns can be rtntten
as’

K(ri,) = 3(1+2var(s,))+0(1/u,2). (10)

In (IO) the notation O(l/u,$ Identifies terms of order I/u: Gwen (IO), for values
of u, plausible wth dally data, the kurtosls exceeds 3, the kurtosls of a normal
variate As a result, measured dally returns for single securltles appear lepto-
kurtlc relative to actual, unobservable returns Agam this effect IS more pro-
nounced for securltles trading less frequently

%etalled results for Poisson tradrng processes appear In a prewous workmg draft of this
paper The results are available from the authors upon request
‘The denvatlon of (10) appears m the appendrx, part (II) Ths general- a prewous
result for zero dnft processes m Clark (1973)
 M Scholes and .I Wdbams, Estrmatmg beras 315

3. Ordinary least squares

With errors rn varjables m the observed market model, ordrnary least squares
applied directly to (2) generates estimators with unattractlke propertles Not
surprlsmgly, the ordrnary least squares estimators (OLSE) a, and 6, of the
coefficients X, and p, in (I) are blased and mconslstent This bias occurs because,
as IS typrcal In models \slth errors In varrables, the regressor I$,, m (2) co\arles
with the residual E:, In fact, In this model It IS stralghtforward to show that
phma, = ai # a, (11)
and
phmb, = Pi # P, (12)

In at least one Important special case, the dIrectIon of the asymptotic bias
m (I I) and (12) can be ldentlfied evphcltly Suppose as before that the non-
tradmg periods S, are dlstrlbuted Independently and ldentlcally over time Also
define the new regresslon coefficients

plus the autocorrelatlon coefliclent

cov(G.t,&1- 11
Y
(1%
“” = std(rh,)std(r,&)’

where std( ) represents the standard devlatlon In this case, as derlked m the
appendix, part (III), the coefficients af, and /I: m (3) and (4) satisfy

(16)
and
B:, = B.-(K +Bi+ --z/3&). (17)

The relatlonshlp ID (16) and (17) between measured coefficients and true
coefficients can now be ldentlfied Examme the top tHo lrnes of fig I, focusmg
on securltles n and m with posrtlve betas Suppose security m IStraded on average
about as frequently as the average security m the Index, where securttlcs m the
index are ranked by average tradmg frequencies If, relative to security m,
securrty n IS traded on average only Infrequently, then the overlap between
perrods of measurement for r:, and r&l IS typlcally large Thus lmphes from
(9) and (13) a relatively large lagged beta /?:- and hence from (16) and (I 7) the
mequahtles a,, -C ai and j?,, > /?; Sumlarly, If, relative to security m, security n
316 M Scholes and J Wdlrams, Es~rmatrng betas

IS traded on average quite frequently, then It IS possrble, although not necessanly

likely, that the overlap between I-;, and r;,+, IS on average large Agam thts
tmphes a, < cc: and /?,, > pi Overall, measured alphas and betas equal on
average true alphas and betas

and

As a result, most remamrng securities-that IS, those trading neither very

frequently nor very Infrequently - exhrbrt the reverse rnequahtles X, > CI~
and P. < P,:
Together, (1 I), (l2), (16), and (17) identify the asymptotic biases for n,, and
b, Securrtres tradmg very Infrequently, plus possibly some tradmg very fre-
quently, have estimators asymptotically biased upward for a, and downward
for b, By contrast, most remaining securnles have OLSE asymptottcally biased
in the opposite dIrecttons Overall, the estimators a, and b, equal on average
across securities the true parameters LI, and /I,
SunlIar observations are possrble for the autocorrelatton coefficient &,, of
the market index Spectfically, from (IS) and (A9) In the appendix, part (III), It
follows that

Pi = +[;%)-I] (18)

If, as argued In section 2, the measured variance var(r,&,) on the market index
understates the true variance var(rMr), then the measured autocorrelatton
coefficient pk appears posrttve Because the sampling estimator j?,,., of the auto-
correlatron cocffictent p; IS a consistent estimator of (18, thts guarantees III
large samples that PM IS also posntve Again thts esttmator doffers from the true
autocorrelatton coefictent for the market Index, whtch has a value of zero.

4. Consistent estimators

From (1 I). (12), (16). and (17), computattonally conventent consistent

estrmators of the coefictents u, and j$, n = I, , N, are tmmedtate Let
b;. b,, and b: represent the OLSE assocrated wtth (13), (4) and (14), res-
pectively Stmtlarly, let ,8,,, represent the samphng esttmator assoctated wtth (15)
Wrth thrs new notatron, the prevrous results imply the conststent estimators

ST’heserewlts follou rmmedlately from the defimtlons of a., 8.) an’, and 8.”
 AI &holes and J Wdlrams, Esrtntarmg betas 317

(19)

and

b, + b, + b,+
j, s (20)
I +2/i,,

Simple cowstent estimators are also powble for residual variances and
covarrances
Computatlonnllj. (19) and (20) have t\\o Important adiantapes Ftrbt,
d, and fl” are constructed from t\io sample mean> plus a sum and quotient of
standard OLSE These OLSE are easllv calculated from available data Second.
the estimators do not depend on detailed assumptions about the probabllit!
dlstrlbutlon generating the sequence of nontradmg times [S,: Instead. (19)
and (20) require only that S, IS Independently and rdentlcally dlstrlbuted over
trrne This latter property IS especially Important because 15,; IS largelv
unobsenable That IS, not only are most detailed assumptions essentially
umerltiable, but also any simple, ;nsl~-tlcally tractable distribution - eg , a
homogeneous Porhson process for trading times - IS unlrkely to fit the Imuted
data For example, because rnformdtlon accumulates betiieen consecutive
closmgs and openings of the NYSE and ASE, trades appear on average unevenly
spaced oker the trading da!
In at least one Important specral case, the estimators (19) and (20) simplif>
still further With monthly data the problem of nonsynchronous trading of
securities has for most common stochs little Impact on recorded returns Because
true returns on common stochs are uncorrelated over time, this implies for
monthly data an estimator p,, oT the autocorrelatlon coefficient for the market
Index close to zero However, rf the asset In question-for example. stock
exchange seats on the Nl SE cjr ASE - IS traded onlj Infrequently, then for that
asset errors of observatlor> can be Important Suppose 11 IndrKes the specific
asset, while ITI represents some seculltj trading on average about as frequently
as the aterage security In the Index, \\here agam securltles In the Index are
ranked by aLerage trading trequencres In thrs case, from the top two lines of
fig 1. the measurement period for r,‘, oberldps the measurement periods for
r;, and I;,-~, but not ri,+l From (A), (1 I ), (12), (13), and (II), this suggests
that onI> b, dnd b, differ qnlficantly from zero In this case (10) simplifies to
8. = b,+b, and (19) slmpirties accordIngI)_’
Not surprwngly, the estimators B,, and /in are asymptotlcally eqwalent to
Instrumental valrnbles estrmators For these ne\\ estlmatorc additional notation
IS necessaq Denote b) the bdd Italic letters r de\latlons from sample means -

9Thls ebrrmator appear> rn Sshuert ( 197)

318 M Scholes and J Wzllrams, Estlmarrng betas

for example,

I = 2, ,T-I

Also ldentlfy by rijrj = r&,_, +r,&+r;,,+, the sum of the rates of return on
the market for the prewous. current, and subsequent periods Usrng this no-
tatlon, the Instrumental karlables estimators become

for the Instrument, the sequence of mowng sums {r,,,3t} The equivalence
betibeen (19) and (21) plus (20) and (22) arlses m the probablhty hmlt as T-r O?
Asymptotic standard errors for (19) and (20) or, alternatively, (21) and (22)
are easily calculated Assume as before that the nontradmg periods S, are
Independently and ldentlcally drstrlbuted over time In this case, as can be
verified from (5) through (9), the residuals t$ In (2) are stationary l%lth a
mean of zero. the variance ok’ E var(&), the first-order autocorrelatlon
p:, = co\+;, , .$,_ ,)/wf , and all other autocorrelatlons zero With theaddltlonal
notation
(23)

and

(24)

the asymptotic standard errors then become”

loFor the derwatlon sez the appendu, part(n)

 M Scltoles and J Wtlltatns, Essrrmarrttgbetas 319

and

Cons&tent estrmators of (25) and (26) are computed by replaclng all population
moments \\lth the respective sample moments

5. Daily returns

In thrs sectlon the above esttmators are applied to dally returns from all
stocks hsted on the New York and American Stock Exchanges between January
1963 and December 1975 Both consistent estimates and ordinary least squares
estimates are calculated for coefficients of five specially constructed portfohos
comprised of secucltles selected by tradmg volume
The composrtlons of the fibe portfolios are as follows For each calendar
year 1963 through 1975, each stock listed on the NYSE and ASE \cas ranked
according to the total number of shares of that security traded during the year ”
Based on this ranhrng five portfohos were formed \\ith portfolio I consisting
of the 20 percent of securltles 151th the lo\\est trading Lolume, portfoho 2 \ilth
the next 20 percent, etc Dally returns on each portfolro, Including the Lnlue
weighted market portfolio, \\ere calculated as the logarithm of one plus the
alllhmetlc average of returns on all securrtles \ilthln that portfoho I2 If m any
given day a security b\as not traded, then no return for that security \\as Included
m any porrfoho for both that day and the subsequent trading day This procedure
excluded less than 2 percent of all avarlzble cecurltles, \\ here securrtles aiallable
for Inclusion In the five portfohos ranged from a minimum number of 1487 in
1963 to a maximum of 2626 In 1973, \\lth an average over 13 years of 2305
During the I3 years there ltere on average approxrmately 251 trading days
per year
In these calculatrons trading volume \\as used as a proxy for the correct,
but unobservable variable, the number of dlstlnct trades III a security Because
about 61 percent on the NYSE occur m round lots of 100 and 200 shares,13
trading volume IS llhely to produce an accurate assignment of securities to the
five portfolios Moreover, as a proxy this iarlable IS clearly superror to the only
other available index, the dollar volume of trades

“Incomplete data on tradmg volume precludes the mcluslon durmg earher )ears of all
secuntles hsted on bothexchanges
“For dally data any differences betsteen thrs definttlon of market returns and the delimtlon
of section 2 are small. Also, some nonstatronarlty IS Introduced III the market Index by usmg
value weights
“See the NYSE Market Data Systems Monthly Memoranda (July 1976)
320 IV Sclroles and J Wdlrams, Es~wnalrng be/as

All estimates for portfolIos I. 1. and 5 appear in tables I through 3 To save

space the correspondmg estimates for portfolios 2 and 4 are deleted in these
tables the column headings reflect the notation of sectlon 4 For example. In
table I the column headlngb are, from left to right, the consistent estlmatps
2, and 0, of alpha and beta for portfolio I, the ordinary least squares ebtlmates
xl of alpha, the OLSE b;, b,, and b: of the lagged current. and lead betas.
the samphng ewmateh P,r of the tirst-order autocorrelntlon coefficient for the
marhet rndeu, and the sampling estimates (5, and PI of the residual standard
de\ ldtlon and arsoclated first-order autocorrelatlon coefficient Throughout the
tables asymptotic standard errors ,~ppcar rn pJrenthe>ei belou the wrrespondlng
estimates ”
Ewmmlng table I, it IS clear that the portftlllo of bccutltles trading at the
loMes1 levels of volume generates estimates 0, uniformly larger than the cc71 re-

spondlng least squares estrmntrs b, The discrepancy IS reduced in table 2

and the inequality reversed In table 3 tor portfollos of securltles trading at
progrewely higher levels of volume As predicted by the ple\roub theory. the
result holds If the talur-\\erghted market portiolro IS heairlv \\etghted \\lth
securmeb tl;ldrng on a\elage relatlvelq frequentI) In this llhelv sltuatlon,
portfolio 5 has an OLSE for beta ns>mptotlcslly blabzd upward B\ contrdbt
the predicted relatIonshIp betireen the consistent estnnator and the OLSE for
alphas cannot be Lerlfied dlrectlv from tdbles I through 3 The standard errors
ale too large
The relationship In tables I through 3 bet\\een consistent estlmstes of betas
and ordmary least squares estimates IS partly obscured bk the apparent slmul-
taneous relationship bet\\een true betas and trading volume In particular. in
the tables larger consistent estimates of betas are associated \ilth larger trading
volumes For portfollos I. 3, and 5, the consistent estimate5 of betas averaged
across all I3 years are 0 674, I 116, and I 368. respectively Adjusting for these
differences In consistent estimates by computing the ratio5 (b,,-/?,,,hfi,,,
n = I, 3, 5. for all years I = 1963, 1975, then gl\es a rough me~~sure of
the relationship betkieen asymptotic bilk and trading volume The results are
dlsplayed In figure 2 As Indicated. average values for the ratios dlHer dram‘ltlc-
ally, Increasing from -0 218 for portfollo I to -0 082 and 0 050 for portfolios
3 and 5, respectively
The remaining estimates In tables I through 3 also appear conwent \s!th the
previous theory In wltchlng from portfollo I to portfolio 3 to portfolio 5, the
lagged betas b; decrease, the lead betas b,f Increase, and the residual auto-
correlation coeficlents p. decrease By contrast, for the residual standard
errors (3, no clear trend IS eildent FInali>, for the market index the a~+
correlation coefficients Ph, are generally slpruficantly poswe Throughout,

“The cnlculatmn of the standard errors for u,, h,- b,,, and b,+ 15stmAu to the dernatton
of (25) and (26) The authors ~111provide detatls upon request
 Table I
Dally returns on low-volume portfolIo regressed on value-uerghlcd marhel returns

Year 6, PI b,- b, b, + Pm tb, PI

1963 -00ooo 0544 00002 0 130 0 303 0 049 -0 058 0 003 0012
(0 0002) (0 065) (0 0002) (0 035) (0031) (0 036) (0 0631
1964 00002 0 561 U 0003 0216 0391 0 090 0 I22 0 00’ OUl9
(0 0001) (0 065) (00001) (0 045) (0 040 1 (0 047) (0 063 )
1965 0 0005 0647 0 0006 0 352 0 524 0 045 0 212 0 002 0 025
(0 0002) (0 052) (0 0002) (0 043) (0 037) (0 049) (0 062)
1966 -00002 0 581 -00003 0391 0 426 0 102 02Yl 0003 0 055
(0 0002) (0 040) (0 0002) (0 032) (0031) (0 040) (0 0611
1967 00011 0651 0 0012 0 267 0 556 -0015 0 I20 0 003 0 I61
(0 0002) (0 054) (0 OUO2) (0 045) (0 035) (0 047) (0 063)
1968 0 0009 0 775 00010 0 462 0 600 0 125 0 266 0 003 0 248
(0 0003) (0 061) (0 0003) (0 048) (0 045) (0 057) (0 065)
1969 -0 0010 0 872 -00010 0 620 0 749 0 183 U 390 0 004 0 216
(0 0003) (0 049) (0 0003) (0 044) (0041) (U 062) (0 060)
1970 -00005 0 809 -00005 0 565 0 679 0 I85 0 383 0006 0 416
(0 0005) (0 056) (0 0005) (0 045) (0 043) (0 058) (0 059)
1971 -0oOoO 0 993 00001 0 526 0848 0 232 U 308 U 004 0 31-1
(0 0003) (0 066) (0 0003) (0 063) (0 052) (0 071) (0061)
1972 -00003 0661 -0 0002 0 364 0 596 U I21 U 317 0 003 U 536
(0 0003) (0 076) (0 0003) (0 057) (0 054) (0 059) (0 061)
1973 -0OOll 0 657 -00012 0 435 0 499 U 071 0 265 11Wh 0 308
(0 0004) (0 056) (0 0004) (0041) (0041) (0 048) (0 062)
I974 -00002 0431 -00003 0 307 0 346 0 024 0 284 0 006 0 4Y3
(0 0006) (0 053) (0 0005) (0 032) (0 033) (0 036) (0 061)
1975 00017 0 577 0 0019 0 402 0415 0 057 0 258 0 UOh 0 165
(0 0005) (0 067) (0 0005) (0044) (0 045) (0 047) (0 061)

- _. ----^__ --I -

_- - - ._-_-_ - - _-_ ._.

 Table 2
Dally relum on Inlermedrale-vnlunl~
portfolIoregressedon value-weIghledmarket returns

Year 6, b,- bJ b,+

1963 00001 0905 00002 0005 0785 -0039 -0058 0003 0 111
(00002) (0065) (00002) (0059) (0034) (0058) (0063)
1964 00003 0851 00003 0233 0754 0071 0 122 0002 0001
(00001) (0066) (00001) (0060) (0040) (0063) (0 063)
1965 00007 1202 00007 O-118 I II9 0 174 0212 0003 0 II4
(00002) (0059) (00002) (0077) (0044) (0082) (0062)
1966 00002 I 149 00001 0565 1005 0248 0291 0004 -0027
(0 0002) (0045) (0 0003) (0064) (0036) (0075) (0061)
1967 OOOl2 I II2 00012 0212 1 123 0045 0 I20 0003 0222
(00002) (0065) (00002) (0079) (0046) (0081) (0063)
1968 00008 1 274 00008 0501 I 187 0264 0266 0003 0298
(00003) (0065) (Oooo3) (0084) (0053) (0091) (0065)
1969 -00005 1330 -00006 0690 1257 0421 0 390 0003 0079
(00002) (0040) (00002) (0 077) (0035) (0 089) (0060)
1970 -00004 1305 -00004 0638 1248 0418 0383 0005 0350
(00004) (0047) (0 0004) (0076) (OOdl) (0087) (0059)
1971 1386 00001 0516 1296 0428 0 308 0003 0105
("OE) (0044) (00002) (0084) (0035) (0088) (0061)
1972 -00003 I021 -00003 0381 0989 0299 0317 0003 0372
(00002) (0059) (00002) (0072) (0049) (0074) (0061)
1973 -00007 I 142 -00009 0 564 0983 0 199 0265 0006 0142
(00004) (005)) (00004) (0064) (0 042) (0075) (0062)
1974 00001 0830 -00001 0462 0724 0116 0284 0007 0175
(00005) (0050) (00005) (0047) (0036) (0058) (0061)
1975 00010 0996 00012 0481 0857 0171 0258 0006 0 342
(OOc@5) (0061) (0 0004) (0060) (0046) (0067) (0061)
 Table 3
Dally returnson hgh-volume portfoho regressedon value-werghtedmarket returns

1963 -0 0000 1336 -00002 -0217 1495 -0097 -0058 0003 0045
(00002) (0067) (00002) (0 100) (0039) (0 101) (0063)
1964 00001 1290 00001 0049 I355 0199 0 122 0002 0217
(00002) (0077) (00002) (0096) (0055) (0095) (0063)
1965 00010 1501 00009 0204 1 597 0337 0212 0003 0121
(0 0002) (0066) (0 0002) (0 110) (0053) (0 107) (0062)
1966 00008 1564 00008 0297 1725 0452 0291 0005 0107
(00003) (0056) (0 0003) (0 115) (0051) (0 109) (0061)
1967 00011 1369 00009 -0 122 1 602 0219 0120 0004 -0010
(00003) (0075) (00003) (0 113) (0055) (0 109) (0063)
1968 00003 1468 00002 0281 I 520 0449 0266 0004 0240
(00003) (0065) (0 0003) (0 110) (0055) (0 104) (0065)
IY69 -00001 I 501 -00001 0458 1531 0682 0 390 0003 -0004
(00002) (0032) (00002) (0 102) (0027) (0090) (0060)
1970 -00003 1437 -00003 0418 1473 0647 0383 0004 0 101
(00003) (0033) (00003) (0096) (0029) (0086) (0059)
1971 -00000 1441 -00000 0 349 1445 0 535 0308 0002 0125
(00002) (0033) (00002) (0095) (0027) (0087) (0061)
lY72 -00004 I267 -00004 0240 1314 0516 0317 0002 0262
(OOW2) (0048) (00002) (0091) (0042) (0081) (0061)
1973 -OO@Ol I311 -00001 0316 1318 0375 0265 0003 0308
(00002) (0030) (00002) (0085) (0026) (0084) (0 062)
1974 00002 1 120 00002 0 320 I 134 0303 0284 0003 0283
(00003) (0025) (0 0003) (0071) (0020) (0072) (0061)
1975 00002 1 172 00001 0290 1174 0312 0258 0003 0161
(00002j (0026) (00002) (0075) (0021) (0075) (0061)
324 M Scholes and J Walhams, Estrmatrng betas

Portfok 5[H,gh\olumel 050

PortfolIo 1 rtw hldnel - 218 I

- 45 -40 -35 -30 - 25 - 20 -15 -10 -05 0 05 10 15 20

Fig 2 Measured betas vs true betas Values of the ratios (b,,-Bnr)/fin, for portfohos
n = 1, 3, 5. and yearsr = 1963, , 1975

these results are consistent with errors of observation which are more sigmficant
for portfolios trading at lower levels of volume.

6. Summary

Given the recent avallablhty of dally data, more powerful tests of the capital
asset pricing model are now possible With dally data, however, there appears a
potentially serious econometric problem. Because reported closing prices
typIcally represent trades prior to the actual close of the trading day, measured
returns often deviate from true returns. The resultmg nonsynchromzatlon
of measured returns across different securities In turn introduces into the
market model the econometric problem of errors m variables With dally data
this problem IS especrally severe
As expected, wth nonsynchronous trading of securities, ordinary least
squares estimators of coefficients In the market model are both biased and
mconsistent In this paper the dn-ections and magnitudes of these asymptotic
biases are specified III detail and then used to construct consistent estimators of
alpha and beta These consistent estimators are subsequently apphed to dally
returns from specrally constructed portfolios comprised of all stocks listed on
the New York and American Stock Exchanges

Appendix

(L) Means, variances, and covariances for measured returns are

 M. &holes and J. Williams, Estimating betas 325

EKI = (1---m,,-.%,-J)pn, (Al)

covcc, cl,> =
3 (l-E[max(s,,,s,,}-min(s,,_,,s,,-l}l)o,,
+cov(&,-&,-I 9%l,-%-lhlPm~ W)

CWG, &-1 > = Ebax Ll --.L~, Ok,,

+ COV(%,- $,-I , h-1 - 4ll,-2hwm (A3)
and
cov (6, f GL> = COVhQ-%,-l, ~mr-~--Sml-~--_I)PnP(m~ 644)

for 7 = 2, . . . , r-1 andn,m= I ,..., N.

To verify (AI) examine fig. 1. The dots on each line indicate times of actual
trades, with the time of the last trade in each period labeled explicitly. Con-
ditional on S, and S,_, the length of the trading period for r,“, is 1 -s.~+&-I -
With an infinitely divisible pricing process, this implies

which equals (Al).

The variances and contemporaneous covariances (A2) are calculated as
fohows. Conditional on S, and S,_, , the length of the period of overlap between
r,“, and r:, is

With an infinitely divisible pricing process, this implies

cov(G, Gt) = Elcov(& &IS,, &-,)I

+cov(H&lS,, Sr-11, E[&l%> $-,I)

= W - [maxh,, h,I--min {s,,-~, ~,,-IH>~,,l
-tcov(U -%r+%t-JPnr (1--sml+4nc-Ih4n)~
which equals (A2). The derivations of (A3) and (A4) are similar.

(ii) The computation of the kurtosis zc(r,S,) is somewhat more lengthy. A sketch
of the derivation is as follows. Again suppose {S,} is stationary. In this case it
follows from (16) that

var(r:J = 0: +var(~,~ -snt-&z. WI

326 M &holes and J Wdhams. Estrmatrng betas

Slmllarly, because r,, IS symmetnc, It can be verified that

V4(G) = E[JW,S, - JW,‘,I&, L)1)41&. %-,I1

+Wvar(GIS,, St-,)(.W,lS,, St-,I-G-~,l)*l
+mw,l&, L,l-m,‘,l)“l
= (I +~.nr(s,,-s,,-,))~4(r,,)
+6(var(s,, -s”,-,)-~~(s”,-s”,-,))~l~ot

+ PS(S”,-L-,)P,4.

where pLj( ) and p4(.) represent third and fourth central moments Squarmg
(A5), dlvldmg the result Into (A6), rearrangmg terms, and recogmzmg
~3(s,,--s,,,_,) = 0 yields (10)

(ar) To derive (16) and (17) recognize that (6) and (7) Imply

cov(r,‘, , &I = ( I - ELmax {s,, s,} - mm Is,, , s,)lb,,

+ 2COV(%,
LhW,,
= onm- {ELmax
b,---s,, Orb,, +COV(G,4Jw,,~
- {&lax {L-S,, O~lo,,+cov(~,, hJw,I
= cov(r,,, ~nrr)-COw,l,rdI~-,)-cov(~~,-*, r;,,) (A7)

MultIplyIng both sides of (A7) by xnnr and summing over n = 1, , N yields

co\ (6, d,,) = cov(r,,, ~*l,)-cow,, G-1)

- cov(4, - , G,,)
3 (AS)

Multlplymg In turn both sides of (A8) by rmnr and again summmg over
n= 1, ,Nglves

(A9)

Dlvldmg (A8) by (A9), rearranging terms, and exploltlng the definitions (4).
(13), (14), and (15) yields the desu-ed result

(10) The asymptotic standard errors (25) and (26) are calculated as follows
From (19) It follows that
 hf Scholes and J Wdhams, Esrmarrrg betas 327

& pllni[\‘(T-3)(d,-a,)]’
--
2

whvzh IS equlialent to (3) Slmllarl~, (20) and (22) ~mpl}

&plln~[\ (T-N,-/%)I2

=-
T-2

\bhlch. \ilth (23) and (24). IS equl\nlent to (16)

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