Dynamic betas for Canadian sector portfolios

The dynamic betas for ten Canadian sector portfolios using the Kalman filter approach are estimated herein and are found to be best described by a mix of the random walk (trend) and mean-reverting (cycle) processes. The relative importance of the trend and cycle components of sector betas is related to different sensitivities of the corresponding sectors to business cycles. Dynamic betas significantly increase the explanatory power of the market model, and particularly for the utilities sector. A dynamic hedging strategy using the one-step-ahead beta forecasts as the hedge ratios produces smaller hedging errors for every sector compared with the hedge ratios calculated from the alternative beta specifications.