We propose a volatility-based threshold capital asset pricing model (V-CAPM) in which asset betas change discretely with respect to innovations in aggregate volatility. Using option-implied measures (i.e. returns on at-the-money straddles written on the S&P 500 index and range of the VIX index) as proxies for changes in aggregate volatility, we find that asset sensitivity to market risk changes significantly when aggregate market volatility is beyond a certain threshold. More specifically,

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... olios of small (big) and value (growth) stocks have significantly higher (lower) betas at times of high volatility. Due to changes in their market betas, small and value stocks are perceived riskier than their big and growth counterparts in bad times, when aggregate volatility is high. The proposed model also does a better job with pricing, especially for value and small portfolios and when aggregate market volatility is high. JEL Codes: C24, G12 * 1 t Akdeniz, L., Altay-Salih, A., Caner, M., 2003. Time varying betas help in asset pricing: The threshold CAPM.