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Unconditional alpha estimates are biased when conditional beta covaries with the market risk premium ("Market-timing") or volatility ("Volatility-timing"). Whereas prior literature focuses on market-timing, the authors demonstrate that volatility-timing has a plausible impact 2 to 10 times larger. Moreover, they identify a novel and potentially substantial bias ("Overconditioning") that can occur any time an empiricist estimates conditional risk using information unavailable to investors - for example proxying with contemporaneous realized beta when asset returns are nonlinear. To correct market- and volatility-timing biases without overconditioning, they show that incorporating realized betas into instrumental variables estimators is effective.
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