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The international CAPM when expected returns are time-varying

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  • Ng, David T.

Abstract

This paper derives a dynamic version of the international CAPM. The exchange-rate risk factors and intertemporal hedging factors are derived endogenously in a model that builds upon Campbell (1993). We provide a theoretical foundation for empirical risk factors often used in international asset pricing, including dividend yields, forward premia and, especially, exchange-rate indices. The model nests the standard CAPM, the international CAPM and the dynamic CAPM. Empirically, the model performs quite well in explaining average foreign-exchange and stock market returns in the US, Japan, Germany and the UK, and exchange-risk and intertemporal hedging factors play some role in pricing these assets. However, while derived in a theoretically sound fashion, these new factors are proportional to covariances with the world market portfolio. Hence, for practical purpose, the model does not perform better than the standard CAPM model. We apply the model to explain returns on portfolios of high book-to-market stocks across countries, and ̄nd that the exchange rate and intertemporal hedging factors do not help to predict these returns. Hence, they cannot account for the two-factor model proposed in Fama and French (1998).
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  • Ng, David T., 2004. "The international CAPM when expected returns are time-varying," Journal of International Money and Finance, Elsevier, vol. 23(2), pages 189-230, March.
    • Handle: RePEc:eee:jimfin:v:23:y:2004:i:2:p:189-230
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    8. Tobias Adrian & Erkko Etula, 2010. "Funding liquidity risk and the cross-section of stock returns," Staff Reports 464, Federal Reserve Bank of New York.
    9. Sie Ting Lau & Lilian Ng & Bohui Zhang, 2012. "Information Environment and Equity Risk Premium Volatility Around the World," Management Science, INFORMS, vol. 58(7), pages 1322-1340, July.
    10. Lucas L. Godeiro & Bruno Ferreira Frascaroli Cassio da Nobrega Besarria & Sinezio Fernandes Maia, 2017. "International CAPM, Dynamic Betas and Optimization of Portfolios: Are countries-risk more profitable?," Journal of Statistical and Econometric Methods, SCIENPRESS Ltd, vol. 6(4), pages 1-3.
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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