The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets

Alberto Giovannini

No 228, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Recent empirical work indicates that, in a variety of financial markets, both conditional expectations and conditional variances of asset 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 (CAPM). 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 on returns to a portfolio composed of dollar, Deutschmark, sterling, and Swiss franc assets, together with United States equities. 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 CAPM are always rejected.

Keywords: Asset Returns; Capital-Asset-Pricing Model; Conditional Variance; Equities; Foreign Exchange; Risk Premia; Time-Varying (search for similar items in EconPapers)
Date: 1988-03
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Citations: View citations in EconPapers (3)

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