The Time-variation of Risk and Return in the Foreign Exchange and Stock MarketsRecent empirical work indicates that, in a variety of financial markets, both conditional expectations and conditional variances of returns are time- varying. The purpose of this paper is to determine whether these joint fluctuations of conditional first and second moments are consistent with the Sharpe-Lintner-Mossin capital-asset-pricing model. We test the mean-variance model under several different assumptions about the time-variation of conditional second moments of returns, using weekly data from July 1974 to December 1986, that include returns on a portfolio composed of dollar, Deutsche mark, Sterling, and Swiss franc assets, together with the US stock market. The model is estimated constraining risk premia to depend on the time-varying conditional covariance matrix of the residuals of the expected returns equations. The results indicate that estimated conditional variances cannot explain the observed time-variation of risk premia. Furthermore, the constraints imposed by the static CAPH are always rejected. |
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19 December 1986 Risk Aversion added heteroskedastic process ARCH Interest Rates asset pricing models asset returns asset supplies British Pound CAPM restrictions Centre for Economic Chi-square test coefficient of risk conditional covariance matrix conditional expectations conditional second moments Correlation DM covariance of returns Date Fig December 1986 Risk Deutsche mark Deutschmark Discussion Papers dollar Economic Policy Research empirical performance estimated conditional variances Exchange Rate financial markets followed by conditional foreign exchange market Frankel German Mark heteroskedastic alternative Heteroskedastic Model Homoskedastic Interest Rates Model Lagrange Multiplier test Log-likelihood Market Estimation Period moments of returns nominal interest rates p-value Percent per week Phillips Curve portfolio predicted Premium process followed rates of return restrictions against heteroskedastic risk aversion parameter risk premia significance of added Simple ARCH Model static CAPM Stock Market Estimation Swiss franc test of significance time-variation of conditional TIME-VARIATION OF RISK unrestricted estimates variation of conditional weekly data