J o u rn a l of Financia!

Economic s 5 (1977) 309-327 r N o r th - Ho l l a nd Publishing C o m p a n y

ESTIMATING BETAS FROM NONS� NCHRONOUS D\TA

Myron SCHOLES a n d Joseph WILLIAMS*

C n a e t s u v of Chicago Chicago IL 60637, US 4

Recei \ed No\ember 1976 icMsed version received O ctob er 1977

N o n s > n ch r ono u s trading of securities introduces into the market model a potentially serious
econometri c problem o f ci rors in variables In this paper properties o f the observed mar ket
mo d el a n d a:»sociated oidinarv least squares estimators are developed in detail In addition,
c o mput ation a ll y convenient, consistent estimators lor parameters of the marke t model are
calculated a n d then applied lo dail> returns o f securities listed in the N Y S E and ASE

1. Introduction
C en tral to c o n t e mp o r a r y theory in finance is the fu n damen tal concept o f
systematic risk o r beta for a security Not surprisingly, much cu r ren t empirical
wo rk m finance focuses on the associated problem o f estimating this systematic
risk o r beta A lth o u g h to d a te almost all estimates have used mo n th l y retu rn s
o n common stocks, recently daily retu rn s have become available * With this
new d a t a mo re powerfu ' empirical tests are now possible
Un fo rtu na te ly, the use of daily d ata in trod u ces into the mark e t model a
potentially serious e con o me tric problem In particular, man> securities listed
o n organized exchanges a re trad e d only mfrequently, with few securities so
'
actively t r a d e d that prices a re recorded almo st continuously Because prices
for most securities a re rep o rted only at distinct random intervals, completely
accu rate calculation of re turn s over a n y fixed sequence o f periods is virtually
impossible in tu rn this introduce s into the ma rk et model the econ o metric
problem of e rro rs m variables With daily d a ta problem ap p ears particu¬
larly severe

*\Ve thank Michael Jensen a n d the referee, G Wilham Schwert, fc* commenl� on a previous
draft, Mar vin Lipson for p r o g r a m m m g assi�tance a nd the C ent e r for Research in Security
Prices, Universitv o f Chicago for hnancial s uppor t
'Dail> d a t a for total returns o n approximate� 4000 securties listed on the New \ ork and
American Stock Exchanges between Julv 2 1962 and December 31, 1975 have been collected at
the C e n te r for Research in Securitv Prices G r a d u a t e School of Business Unrversiiv of Chicago
�Fama (1965) and f i s h e r (1966» fir�t recognized the nontrading o f securities \ potentially
serious empirical problem Some o f the results in this paper ap p e a r in a set ot unpublished notes
bv Oldrich Vasichek, G r a d u a t e School o f Mana ge me nt, University o f Rochester Related
results a p p e a r in Cohen, Maier, Schwartz, a n d Wh i t co m b (1977)
310 M Scholes and J Wilhams� Estimating betas

In section 2 o f this paper, properties of the ma r k e t model with n o n s yn c h r o n o u s

d ata are developed m detail A s su mi n g th at t r u e in stan taneou s returns on
securities a re normally distributed, it is shown that variances an d co v i r i an c es
of repo rted re turn s diifer from c o rr es p o n d in g variances a n d c o va n a n c cs o f true
retu rn s Under plausible restrictions on trad ing processes, measu red \ a r ia n c es
for single securities overstate tru e variances, while measu red c o n t e mp o r a n e o u s
covariances understate in absolute mag n itu d e true covariances Also, repo rted
retu rns on single securities a p p e a r serially correlated a n d leptokurtic relative
to actual returns Addition al properties for measu red return s on portfolios o f
securities are reported
With errors m variables in the ma rk et model, o r d i n a r y le?st squares estimato rs
of b o th alphas a n d betas for almost all securities are biased a n d inconsistent
In this particular proble m with e rro rs fro m n o n s yn c h ro n o u s trad in g o f securities,
there l e ma ms vvithm r e p orte d re turn s sufficient structure to identify both the
direction a n d ma gn itude o f a n y a symp to tic bias Accordingly, m section 3 it is
shown that securities tradin g o n average eith er very frequently o r very infre¬
q u en tly have o rd /n a r y least squares estimato rs asymptot/cally biased u p wa rd
for alphas a n d d o w n wa r d for betas By co n trast, for those remain in g securities
with mo re average trad in g frequencies, least squares estimators of alphas a n d
betas a re asymptotically biased in the o p po site directions
In section 3 co mp u ta tion a lly con venient, consistent estimators for coefficients
in the mark e t model a r e co nstruc te d T h e consistent estimator for beta is calcu¬
lated as a c o mb in a t io n o f o rd in a r y least squ ares estimato rs Specifically, the
su m of betas estimated by regressing the retu rn o n the security against retu rn s
o n the ma r k e t from the previous, c u rren t, a n d subsequen t periods is divided by
o n e plus twice the estimated a u to c o r re la t io n coefficient for the ma r k et index
In tu rn these consistent estimators o f alp h a a n d beta are shown to be equivalent
to in stru me n ta l variables estima to rs which use as a n in stru men t the moving su m
of measu red rates o f re tu rn o n the ma r k e t for the previous, cu rrent, a n d sub¬
sequen t periods In ad dition, a symp to tic s t a n d a r d erro rs for these estimato rs
a r e calculated
In section 5 the consistent estimators are applied to daily retu rns fro m
securities listed on the N e w Yo r k and A me rican Stock Exchanges between
Janu ary, 1963 a n d D e cemb e r, 1975 Estimates o f alphas a n d betas are calculated
a n d th en c o mp a r e d to the c o rre sp o n d in g o rd in ar y least squares estimates for
portfolios co mp rised of securities selected by trad in g volume Almost with o u t
exception, these estimates a re consisten t with the predictions from section 4
All basic results cited m the text a re derived in the ap p en d ix

2. The problem

Implicit behind the basic capital asset p r/cmg mo d el m c o n t i n u o u s time is the

assu mp tio n tha t all risky securities have prices distribu ted as infinitely divisible,
 A/ ScholesandJ WiUiams� Estimating betas 311

� With this
lognormal r an do m variables assumption the continuously com¬
pounded returns r„, on risky securities « = I, , A', as calculated over any
intervals [/ —1, /], r = 1, ,7, are joint normally distributed with the constant
means //„, constant variances (t¿, and constant covanances n nu
n,m =1, , V In turn this implies that the corresponding rates of return
o" the market index M are normally distributed with the
constant mean constant variance and constant covanances
/Í = 1, , N Here represents the constant percentage weight of security n
in the market index M Collectively, these assumptions imply the simple market
model

'n/ '�11 1/i "i" �/iM

where = t¡n — pjhí and /?„ = are the constant coefficients alpha and
beta The residual orthogonal to is normally distributed with a zero
mean plus constant variances and covanances
in practice, however, the market model (I) is not continuously observable
Because most securities trade at discrete, stochastic intervals m time, with pnces
recorded only at points of actual trades, (I) cannot be observed at all times
0 � t � T This discontinuous trading of secunties introduces into the market
model the common econometric problem o f errors in variables
Specifically, consider any sequence o f distinct, uniformly spaced points m
time r = 1, yT with the corresponding intervals [/—K r] During any such
interval there occurs either no trade, no observed price, and hence no calculated
return, or, alternatively, at some random time 0 � � 1, a last trade
and consequently a reported closing pnce Here represents the residual
portion of trading period / during which no trades in security n occur If over
any two consecutive intervals closing pnces are reported, then a rate of return
can be calculated for the corresponding period [/—1 —í„í-i , (See
1
figure ) Collecting all such measured rates of return, and ignoring periods over
which no trades occur, generates Lhe sampling sequence differing m general
from {/•„,} In turn this implies for the market index a measured sequence
� Errors
{r�,} or returns, / u< = Z«=i'"«< W, also differing from {r�,} in
variables result when measured returns are used as proxies for true unobservable
returns

�hor a discussion o f this pricing process see M e r t o n (1973) Mo re generally, the results o f
this paper require only that the pricing process be infinitely divisible with independent incre¬
ments This permits, for example, c o m p o u n d Poisson processes
■�AJI information a b o u t returns over da>s in which no trades occur is ignored This greatl>
simplifies the subsequent estimators
®Some variability over time in the ma r ke t index is introduced by excluding from the index
securities n ot t r a d m g during the particular period Presumably, these effects are mmor Vari¬
ability in the ma r ke t index has n o cffcct o n the results of section 2 nor on the major results (16)
a n d (17)
312 M Scholes andJ Williams� EsUmaiwg betas

t-1 t t*l

Measured
Returns 4 1

security n
�nl-1 Sn. 1 C
i ■ �nt H
t-l-

•
■"mt

1
secarity n ' S
, mt +1

f-'m.

True
Returns ""n. �r»t + 1

security n

""mt 1

sccurify m

t-l t
Fig 1 Measured returns versus true returns for securities u and m over periods t and r4-1

With these presumably unavoidable errors jn variables, measured returns are

no longer generated by a simple Gaussian process Instead, measured returns
arise from a subordmat ed process \vith parameters dependent upon realizations
of the directing process determining actual times between trades In terms of the
market model (1), this subordination imphes

C = «n + iS�'í/í + eír. (2)

With t h e coefficients

< = (3)
 M Scholes and J )Vilhams� Estimating betas

and
OS = (4.
var(ri�,)

Generally (3) and (4) differ from the corresponding coefficients a„ and P„ in (I)
Again t he residual a*, has a zero mean and zero covariance with the regressor
In (2) no restrictions are placcd on the sequence of nontradmg periods
\ 1 /» ' •�/v Í)
All differences between the observed mar ket model (2) and the true model (I)
reflect differences between measured returns and true returns In general, with
errors of obser\atJon, measured returns deviate from normality with moments
dependmg on properties of both true returns and nontradmg periods Means,
variances, and covariances for measured returns are derived in the appendix,
part (i) In the plausible special case with all nontradmg periods 5", independently
and identically distributed over time, these moments simplify as follows

E [ r l ] = n,„ (5)

\aT{r'„,) = {\ +2\ ar{s „)l vl }al , ((>)

With the coefficient of variation v„ =

co\(r�,,r'„,) = {I-£[max{i„,
+ 2 COV (j„, s„)/p„„v„v„ }ff„„, (7)

With the correlation coefficient p„„ = (T„Ja„a„,

cov(r„',,= -{var(j„)/i'i}ff� (8)

an d

cov(r„',,= {£: [ max {i „ -J „,0}]

+ C OV(5„,5j/p (9)

In this special case all remaining covariances of various lags disappear

The properties of (5; through (9) are interesting With nontr admg periods S,
distributed independently and identically over time, expectations of measured
returns (5) for single securities always equal true mean returns By contrast, for
single securities, measured variances (6) overstate true variances, while measured
aut ocovari ances( 8)oflagone appear negative Also, measured contemporaneous
covariances (7) differ from true covariances, while measured covariances (9) of
lag one deviate from zero Finally, all remaining covariances for lags greater
t han one vanish in the absence of dat a from periods during which no trading
occurs
314 M Scholes and J Williams� Estimating betas

With daily data additional simplifications in (6) through (9) are possible.
Specifically, for daily returns on NYSE and ASE common stocks, the co¬
efficient of variation v„ exhibits an average value roughly m the range o f 30 to 40.
This implies that for single securities measured variances (6) closely approxi¬
mate true variances while measured autocovariances (8) closely approximate
zero In addition, for single securities measured contemporaneous covariances
(7) understate in absolute magnitude true covariances, while measured co-
variances (9) of lag one share with true contemporaneous covariances 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, in (7) the discrepancy of measured contemporaneous covariances
from true covariances is greatest when one security trades on average very
frequently while the remaining security tiades very infrequently Similarly, in
(9) the discrepancy is greatest when security n trades very frequently while
�
security in trades very infrequently
In turn these properties have implications for daily returns from large
portfolios Suppose that in practice returns on individual securities are pre¬
dominantly positively correlated Also recall that for large portfolios variances
are primarily determined by the covariances of returns among component
securities From (6) and (8) this implies that measured variances for daily
returns on large portfolios 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 with the corresponding results for single
securities
For individual securities reported returns deviate from normality This
deviation is measured in part by the kurtosis of reported returns Assuming
as before that the nontradmg periods 5, are independently and identically
distributed over time, the kurtosis o f measured returns can be written
as�

= 3(l+2var(j„)) + 0(l/i;2). (10)

In (10) the notation 0( I/u�) identifies terras of order \¡v\ Given (10), for values
of i>„ plausible with daily data, the kurtosis exceeds 3, the kurtosis of a normal
varíate As a result, measured daily returns for single securities appear lepto-
kurtic relative to actual, unobservable returns Again this effect is more pro¬
nounced for securities trading less frequently

�Detailed results for Poisson trading processes appear in a previous working draft of this
paper The results are available from the authors upon request
'The denvation of (10) appears in the appendix, part (ii) This generalizes a previous
result for zero dnft processes in Clark (1973)
 M Scholes and J Williams� Estimating betas 315

3. Ordinary least squares

With errors in variables in the observed market model, ordinary least squares
applied directly to (2) generates estimators with unattractive properties Not
surprisingly, the ordinary least squares estimators (OLSE) and b„ of the
coefficients and jS„ m (I) are biased and inconsistent This bias occurs because,
as IS typical in models with errors m variables, the regressor in (2) co\aries
with the residual e�, In fact, in this model it is straightforward to show that

plima„ = (11)
and
plim6„ = p„ (12)

In at least one important special case, the direction of the asymptotic bias
in (II) and (12) can be identified explicitly Suppose as before that the non-
tradmg periods 5, are distributed independently and identically over time Also
define the new regression coefficients

„ ,13,
var(r¿,_,)
and
. ,
,14,

plus the autocorrelation coefficient

. , cov(r(�,,r��,_i)
std(r�,)std(rX„_i)'

where std( ) represents the standard deviation In this case, as derived m the
appendix, part (ui), the coefficients a* and in (3) and (4) satisfy

< = <X� + (Pn-Pn)fM (16)

and
�;; = �n-(i5r+�r-2tó)- o?)

The relationship in (16) and (17) between measured coefficients and true
coefficients can now be identified Examine the top two lines of fig 1, focusing
on securities n and m with positive betas Suppose security m is traded on average
about as frequently as the average security in the index, where securities in the
index are ranked by average trading frequencies If, relative to security m,
security n is traded on average only infrequently, then the overlap between
periods of measurement for and is typically large This implies from
(9) and (13) a relatively large lagged beta and hence from (16) and (17) the
inequahties a„ < and Similarly, if, relative to security m, security n
316 M Scholes and J WilliamSy Estimating betas

IS traded on average quite frequently, then it is possible, although not necessarily

likely, that the overlap between and + i is on average large Again this
implies of„ < and p„ > Overall, measured alphas and betas equal on
average true alphas and betas

I = 0 = X
1 n=i
and
�
X Pn�nM = 1 = X Pn�nM
n-\ n=:l
As a result, most remaining securities - that is, those trading neither very
frequently nor very infrequently - exhibit the reverse inequalities a„ > oil
and p„ < PI
Together, (11), (12), (16), and (17) identify the asymptotic biases for o„ and
b„ Securities trading very infrequently, plus possibly some trading very fre¬
quently, have estimators asymptotically biased upward for and downward
for b„ By contrast, most remaining securities have OLSE asymptotically biased
in the opposite directions Overall, the estimators a„ and equal on average
across securities the true parameters and P„
Similar observations are possible for the autocorrelation coefficient of
the market index Specifically, from (15) and (A9) in the appendix, part (in), it
follows that

("8)
Lvar(r�„) J

If, as argued in section 2, the measured variance var(r��,) on the market index
understates the true variance var(/*jvf,), then the measured autocorrelation
coefficient appears positive Because the sampling estimator of the auto¬
correlation coefficient pj, is a consistent estimator of (18), this guarantees in
large samples that is also positive Again this estimator differs from the true
autocorrelation coefficient for the market index, which has a value of zero.

4, Consistent estimators
From (11), (12), (16), and (17), computationally convenient consistent
estimators of the coefficients and P„, n = \, , N, are immediate Let
b~, b„, and b� represent the OLSE associated with (13), (4), and (14), res¬
pectively Similarly, let p�v, represent the sampling estimator associated with (15)
With this new notation, the previous results imply the consistent estimators

®These results follow immediately from the d e fi m t i o n so f A , an', and

 M Scholes and J Williams� Estimating betas 317

1 . 1 ''Z}
■n
(19)

and

a = "*"�n+�n�
(20)

Simple consistent estimato rs a re also possible for residual variances and

covariances
Computational!},, (19) a n d (20) have two mi p o r l a n t ad\aniages First,
6l„ a n d P„ a re co n stru c te d fro m two sample mean> plus a su m a n d quotient o f
stan d ard O LS E These O LS E a re easilv calculated from available data Second,
the estimato rs do not d e p e n d on detailed assu mp tio n s ab o u t the probability
distribution generatin g the sequence of n o n t r a d m g tmies [S,) Instead, (19j
a n d (20) require only that S, is independently an d identically distributed over
time This latter p rop e rty is especially i mp o rtan t because {5�} is largelv
unobsenable T h a t is, not only are most detailed assu mptio ns essentially
-
un\eriiiabie, bu t also a n y simple, anal>lically tractable distribution e g , a
h o mo g en eo u s Poi�son process for trading times-is unlikely to fit the limited
d ata Fo r example, because info rmation accu mu lates between consecutive
closmgs a n d openings, o f the NYSE a n d ASE, trades a p p e ar on average unevenly
spaced over the trad ing da_\
In at least o n e i mp o r t a n t i�pecial case, the estimators (19) a n d (20) simplify
still further With mo n th ly d a t a the p ro b lem o f n o n s yn ch ro n o u s t r a d mg of
securities has for most c o m mo n stocks little impact on recorded returns Because
true retu rn s on c o m m o n stocks a re un co rrelated over time, this implies for
mo n th ly d a ta an estimator o f the au to co rrelation coefficient for the mark et
index close to zero However, if the asset m question-for example, stock
exchange seats on the SE o r ASE - is traded onl> infrequently, then for that
asset errors of ob serva tion can be imp o rtan t Suppose // indexes the specific
asset, while t7i represents so me secuiit> trad in g on average ab o u t as frequently
as the average security in the index, wh ere again securities m the index are
r an k e d by average trad ing frequencies In this case, fro m the top two lines o f
fig i, the me a su re me n t period for overlaps the measu re m en t periods for
and but not From (4), (11), (12), (13), a n d (14), this suggests
that onlv b„ a n d b~ differ significantly from zero In this case (20) simplifies to
a n d (19) simplifies accordinglv �
N o t surprisingly, the estima tors and are asymptotically equivalent to
instru men tal vaiiables estima to rs F o r these new estimators addition al notation
IS necessar> D e n o t e b> the bold italic letters r deviations from sample mean-* -

�This ej>umaior appear") in Schwert (1977)

318 M Scholes and J Williams� Estimating betas

for example,

r'n. � ' ñ ., t = 2, ,T-\

� t=2

Also identify bythe sum of the rates of return on

the mar ket for the previous, current, an d subsequent periods U s mg this no¬
tation, the mst rumental variables estimators become

(21)

and

(22)

for the mstrument, the sequence of moving sums The equivalence

between (19) and (21) plus (20) and (22) arises m the probability limit as co
Asymptotic standard errors for (19) and (20) or, alternatively, (21) and (22)
are easily calculated Assume as before that the nontrading periods 5, are
independently and identically distributed over tmie In this case, as can be
verified from (5) through (9), the residuals ej, m (2) are stationary with a
mean of zero, the variance = varíe��), the first-order autocorrelation
p�„ = cov(e�(, £�,_,)/a)�\ and all other autocorrelations zero With the additional
notation
' V M jr + ,1 ,> r'í Mót'
s _ cov(rí�3, ,3,)
~ (23)
sld(/-;�3,+i)std(r¿,3,)
a nd
- cov• (/■;,„
V Aff < 'rlti,)
M
PA/.M3
ps _ (24)
var(rX,3,)

the asymptotic standard errors then b e c o me ' "

= (I
i��V�irnW{T-2)0„-P„)]Y� +2p:�'�
(25)
* °For the derivation sec the
appendix, part (i>)
 M ScholesandJ Wiihams, Estimating betas 319

and

r 1+2pX/3 V" (26)

T-2 P'i, Af3var(/-i,3,)J

Consistent estimators of (25) and (26) are computed by replacmg all population
moments with the respective sample moments
■

=
5. Daily returns
{
In this section the above estimators are applied to daily returns from all
stocks listed 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 o f five specially constructed portfolios
comprised of securities selected by trading volume
The compositions of the five portfolios are as follows For each calendar
year 1963 through 1975, each stock listed on the N YS E and ASE was ranked
according to the total number of shares of that security traded during the year
Based on this ranking five portfolios were formed with portfolio I consisting
o f the 20 percent o f securities with the lowest trading \olume, portfolio 2 with
the next 20 percent, etc Daily returns on each portfolio, including the \al ue
weighted market portfolio, were calculated as the logarithm o f one plus the
aiiihmetic average of returns on all securities withm that portfolio If m any
given day a security was not traded, then no return for that security was included
in any portfolio for both that day and the subsequent trading day This procedure
excluded less than 2 percent of all available securities, where securities available
for inclusion in the five portfolios ranged from a minimum number of 1487 in
1963 to a maximum o f 2626 in 1973, with an average over 13 years of 2305
During the 13 years there were on average approximately 251 trading days
per year
In these calculations trading volume was used as a proxy for the correct,
but unobservable variable, the numbei of distinct trades in a security Because
about 61 percent on the NYSE occur in round lots o f 100 and 200 shares,*�
trading volume is likely to produce an accurate assignment of securities to the
five portfolios Moreover, as a proxy this variable is clearly superior to the only
other available index, the dollar volume o f trades

"Incomplete d a t a o n trad ing volume precludes the inclusion during earlier \ e a r s o f all
securities listed on both exchanges
*�For daily d a t a any differences between this definition o f ma r ke t returns a nd the definition
o f section 2 are small. Also, some n o o s t a t ion a n t y is introduced in the m a r ke t index by using
value weights
� �See the NYSE Market Data
Systems M o n t h l y Memoranda (July 1976)
320 i\í ScholesandJ Williams� Estimating betas

All estimates for portfolios I, 2, a n d 5 a p p ea r in tables 1 th ro u g h 3 To save

space the co rre sp on d ing estimates for p o rtfoho s 2 an d 4 are deleted in these
tables the c o lu mn headings reflect the n o tatio n o f section 4 Fo r example, in
table 1 the c o lu mn head mgs are, from left to right, the consistent estmial��s
«1 a n d o f alpha a nd beta for portfolio I, the o rd in ar y least squares estimates
o f a l p h a, the O LS E 6,, and of the lagged curren t, and lead betas,
the samp lmg estimate� o f the first-order au to co rrelatio n coefficient for the
ma rk et index, an d the sa mp lmg estimates oO, a n d of the residual s t a n d a rd
deviation and associated first-order au toco rrelatio n coefficient T h r o u g h o u t the
tables asymp totic sta n d a rd errors a p p e a r in parenthei.es below the correspo nd ing
estimates
E x d mmmg table I, it is clear that the portfolio o f �ecuIlt!es trading at the
lowest levels o f volume generates estimates uniformly larger than the coi re¬
sp on d in g least squares estimates This discrepancy is reduced in table 2
a n d the inequality reversed in table 3 tor portfolios o f securities trad ing at
progressively higher levels o f volume As predicted by the pievious theory, the
result holds if the \alue-v\eighted ma r k e t portfolio is heavily weighted with
securities t i a d m g on ave iag e relatively frequentlv in this likely situation,
portfolio 5 has an O LS E for beta asymptotically biased u p ward B\ co n trast
the predicted relationship between the consistent estimator and the O LS E for
alphas ca n n o t be verified directly fro m tables I th ro u g h 3 T h e stand ard erro rs
a i e to o large
T h e relationship m tables I th ro u g h 3 between consistent estimates o f betas
a n d ord in ary least squares estimates is partly obscured bv the a p p are n t simul¬
tan eo u s relationship between true betas an d trad ing volu me In particular, m
the tables larger consistent estimates o f betas are associated with larger trad ing
volumes Fo r portfolios 1, 3, a nd 5, the consisten t estimates o f betas averaged
across all 13 years a re 0 674, 1 116, a n d I 368, respectively Adjusting for these
differences in consistent estimates by co mp u tin g the ratios —�nt)lÍKn
n = 1,3,5, for all years / = 1963, , 1975, then gives a ro u gh measu re of
the relationship between asymp to tic bias and trad in g volume T h e results are
displayed in figure 2 As indicated, average values for the ratios difter dramatic¬
ally, increasing fro m — 0 218 for portfolio 1 to —0 082 a n d 0 050 for portfolios
3 a n d 5, respectively
T h e rema ining estimates in tables I t h r o u g h 3 also a p p e a r consistent with the
previous theory in switching from portfolio I to portfolio 3 to portfolio 5, the
lagged betas b ~ decrease, the lead betas increase, a n d the residual auto¬
correlation coefficients decrease By contrast, for the residual stan d ard
erro rs tt)„ no clear trend is evident Finally, for the ma r k et mde\ the auto¬
correlation coefficients a re generally significantly positive Throughout,

' "�The calculation of the �iiandard errors for a,, h„~ b,„ and bn� is similar lo the derivation
of (25) and (26) T he authors will provide details upo n request
 M ScholesandJ WiUiamSy Estimating betas 3

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322 A/ Scholes and J Williams� Estimating betas

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 A/ Scholes and J WilhamSy Estimating betas 323

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324 M Scholes and J H�tUiams, Estimating betas

Po rt fo lio 5 OSO
[ H . g h Volu me]

Po rtfo lio 3 [ i n l er m ed ol e Volu me]

-082

Po rt fo lio 1 fL ow Volume)

-218

t■ I �
0 5 10 15 20
ra ti o valués
-45 -40 -35 -30 -25 -20 -15 -10 -05

Fig 2 Measured betas vs true betas Values of the ratios for portfolios
n = 1, 3, 5, and years r == 1963, , 1975

these results are consistent with errors o f observation which are more significant
for portfohos trading at lower levels of volume.

6, Summary
Given the recent availabihty o f daily data, more powerful tests of the capital
asset pricing model are now possible With daily 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 resulting nonsynchronization
of measured returns across different securities in turn introduces into the
market model the econometric problem of errors in variables With daily data
this problem is especially severe
As expected, with nonsynchronous trading of securities, ordinary least
squares estimators of coefficients in the market model are both biased and
inconsistent In this paper the directions and magnitudes of these asymptotic
biases are specified in detail and then used to construct consistent estimators o f
alpha and beta These consistent estimators are subsequently applied to daily
returns from specially constructed portfolios comprised of all stocks listed on
the New York and American Stock Exchanges

Appendix
(0 Means, variances, and covariances for measured returns are
 M. Scholes and J. Williams� Estimating betas

cov (r;,,r �,) � (l~E[max{s„,, s„,}~mm{s„t-u s„t-i}])�nm

COVi/";��,— £�[lliax Í
+ C0V(5„,-i„,_i , �ml-1
and
COV(/*„(, = C0V(5„, *�fli-l ) �mr-T

for T = 2,..., Í — 1 and n,m = ],..., iV.

To verify (AI) examine fig. i. 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 Sf and 5(_j the length of the trading period for is 1 — .
With an infinitely divisible pricing process, this implies

-�[(1 *�nr�~*�nf—

which equals (Al).

The variances and contemporaneous covariances (A2) are calculated as
follows. Conditional on 5, and , the length of the period of overlap between
Kt and is
min {1 1 -i„,} + min

With an infinitely divisible pricing process, this implies

cov(r;,, r�,) = ¿"[coviC, S�-i)]

+ cov(£[r,M�„ 5,_ J, £[r�,15„ S, . , ] )

= £[(1 -[max{5„,, 5�J -min{5„,_j,

-f COV((l (1 -

which equals (A2). The derivations of (A3) and (A4) are similar.

(ii) The computation of the kurtosis K:(r�,) is somewhat more lengthy. A sketch
of the derivation is as follows. Again suppose {5,} is stationary. In this case it
follows from (16) that

var(r�,) = (T� + var(s„,-s„,_i)/i� (A5)

326 A/ ScholesandJ Williams, Estimating betas

Similarly, because is symmetric, it can be verified that

+ 6£[var(/-„MS,, 5,_,)(£K|S„ S , _ l ] - £ k � ] ) � ]

+ £[(£-[r„M5„5,_,]-£[Cr]

+ 6(var (i„, - _ ,) - - 1 ))/'n<�n

+ l�ÁSn,-Sn,-l)�C, ÍA6)

where �j( ) and �4(-) represent third a nd fourth central moments Squaring
(A5), dividmg the result into (A6), rearranging terms, and recognizing
= 0 yields (10)

(///) To derive (16) a nd (17) recognize that (6) and (7) imply

cov(r„\,/-®,) = ( I-£" [ max{5 „,5„} -mi n{j „,5„}]) íT„„

4-2cov(5„,0/U'm

= (7„„- {E[rr\SL\{s„-s�,0}] (T„„ + co\(s„,

- {£[max 0}K„ + cov(j„,

= cov(r„,, /�,)-cov(/*;,, C-i)-cov(r„\_i, r„\,) (A7)

Multiplying both sides o f (A7) by a nd summing over /? = 1, , N yields

cov(r„�, rift) = cov(r„,, r¡�f,)-cow(r'„,, /"a/,-,)

- cov (/•„",_ 1, J (A8)

Multiplying in tur n both sides of (A8) by a nd again summing over

n = \, , N gives

var(ri/,) = \ 'a r {r j , ¡,) -2 co \( r l i ,, (A9)

Dividing (A8) by (A9), rearranging terms, an d exploiting the definitions (4),

(13), (14), an d (15) yields the desired result

(w) The asymptotic standard errors (25) a nd (26) are calculated as follows
From (19) it follows that
 M ScholesandJ Williams, Estimating betas 327

- �
pi I m [ X'(7- 2 ) ( 5 „ aj]

-2
plim (/}„-/?„) plim ZZ

p''"� I
[firrZ

= Pi'mh +0+
�«r(l+2/a
(r-2)(�„-/?„)]�|/ii,

which IS equnaleiit to ( 2 5 ) Similarlj, (20) and ( 2 2 ) imply

íT-2)(�„-P„)]'
�plmi[v

plim X Z''u3.Cm£>ííJ:
1 T-2 , ,
T-2
plim Ml' \l3t
T-2 r

1 (orvar+ 2 i o l ' p l , c o \ ( i I n , . / ;,j,-,)

T-2 [cov(/i,„.\,3,)]-

which, with (23) and ( 2 4 ) , is equualent to ( 2 6 )

References
Clark, P, 1973, A s u bo rdin at ed stochastic process model u i i h finite speculative prices,
Econometrica41,135-155
C o h e n K ,S Maier, R Schvsarts and D Whj tco mb, 1977, On the existence o f serial correlation
in an efficient ma r ke t. Wo r kin g P aper no 199, G r a d u a t e School o f Busmess Administration,
D u k e Uni\ersit>
F a m a E , 1965 Tomorrou on the New Yor k Stock Exchange, Journal of Business» 38, 285-299
F i s h e r, L , 1966, Some new slock market indices, Journal of Business 39,191 -225
M er ton R , 1973, intertemporal capital asset pricing model, Econometrica 16, 868-887
N Y S E M a r ket Data S>stems Monthly M e m o r a n d a , Statistical Reference Tables, July 1976,
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Schwert, G , 1977, Stock exchange seats as capital assets, Journal of Financial Economics 4,
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