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A variance equality test of the ICAPM on Philippine stocks: post-Asian financial crisis period

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  • Rodolfo Aquino
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    Abstract

    The study examines whether Fama's discrete version of Merton's intertemporal CAPM (ICAPM) can explain the negative market risk premium and the cross-sectional variability of Philippine stock returns after the onset of the Asian financial crisis in July 1997. The change in foreign exchange rate, in addition to the change in market risk premium, is used as a state variable of hedging concern to investors. The relationship of Fama's multifactor minimum-variance (MMV) portfolio to the Markowitz minimum-variance (MV) portfolio is characterized in terms of the equality of the return variances for the same expected return. A test due to Basak et al. (2002) is then used to verify the equality of the return variance of a derived tangency portfolio along the MMV frontier to an MV portfolio with the same sample mean return. The results do not reject the ICAPM during the period covered by the study. Thus, the model provides a plausible explanation both for the cross-sectional variability of stock returns and the negative market risk premium within the framework of mean-variance optimizing investors.

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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Economics.

    Volume (Year): 38 (2006)
    Issue (Month): 3 ()
    Pages: 353-362

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    Handle: RePEc:taf:applec:v:38:y:2006:i:3:p:353-362

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    1. Jorion, Philippe, 1991. "The Pricing of Exchange Rate Risk in the Stock Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(03), pages 363-376, September.
    2. Merton, Robert C., 1972. "An Analytic Derivation of the Efficient Portfolio Frontier," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 7(04), pages 1851-1872, September.
    3. Rodolfo Aquino, 2005. "Exchange rate risk and Philippine stock returns: before and after the Asian financial crisis," Applied Financial Economics, Taylor & Francis Journals, vol. 15(11), pages 765-771.
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    7. Basak, Gopal & Jagannathan, Ravi & Sun, Guoqiang, 2002. "A direct test for the mean variance efficiency of a portfolio," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1195-1215, July.
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    9. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-52, September.
    10. Robert Faff & Howard Chan, 1998. "A multifactor model of gold industry stock returns: evidence from the Australian equity market," Applied Financial Economics, Taylor & Francis Journals, vol. 8(1), pages 21-28.
    11. Huberman, Gur & Kandel, Shmuel, 1987. " Mean-Variance Spanning," Journal of Finance, American Finance Association, vol. 42(4), pages 873-88, September.
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