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The International CAPM and a wavelet-based decomposition of Value at Risk

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  • Viviana Fernandez

Abstract

In this article, we formulate a time-scale decomposition of an international version of the CAPM that accounts for both market and exchange-rate risk. In addition, we derive an analytical formula for time-scale value at risk and marginal value at risk (VaR) of a portfolio. We apply our methodology to stock indices of seven emerging economies belonging to Latin America and Asia, for the sample period 1990-2004. Our main conclusions are the following. First, the estimation results hinge upon the choice of the world market portfolio. In particular, the stock markets of the sampled countries appear to be more integrated with other emerging countries than with developed ones. Second, value at risk depends on the investor's time horizon. In the short run, potential losses are greater than in the long run. Third, additional exposure to some specific stock indices will increase value at risk to a greater extent, depending on the investment horizon. Our results go in line with recent research in asset pricing that stresses the importance of heterogeneous investors.

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Bibliographic Info

Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp075.

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Date of creation: 15 Dec 2005
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Handle: RePEc:iis:dispap:iiisdp075

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Keywords: wavelets; ICAPM; value at risk.;

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  1. Connor Jeff & Rossiter Rosemary, 2005. "Wavelet Transforms and Commodity Prices," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 9(1), pages 1-22, March.
  2. Ramsey, James B. & Zhang, Zhifeng, 1997. "The analysis of foreign exchange data using waveform dictionaries," Journal of Empirical Finance, Elsevier, Elsevier, vol. 4(4), pages 341-372, December.
  3. Bernard Dumas, 1994. "A Test of the International CAPM Using Business Cycles Indicators as Instrumental Variables," NBER Working Papers 4657, National Bureau of Economic Research, Inc.
  4. Ramsey, J.B., 2002. "Wavelets in Economics and Finance: Past and Future," Working Papers, C.V. Starr Center for Applied Economics, New York University 02-02, C.V. Starr Center for Applied Economics, New York University.
  5. Solnik, B H, 1974. "The International Pricing of Risk: An Empirical Investigation of the World Capital Market Structure," Journal of Finance, American Finance Association, American Finance Association, vol. 29(2), pages 365-78, May.
  6. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(1), pages 116-31, February.
  7. Ramsey James B., 2002. "Wavelets in Economics and Finance: Past and Future," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 6(3), pages 1-29, November.
  8. James Ramsey, 1999. "Regression over Timescale Decompositions: A Sampling Analysis of Distributional Properties," Economic Systems Research, Taylor & Francis Journals, vol. 11(2), pages 163-184.
  9. Lin Shinn-Juh & Stevenson Maxwell, 2001. "Wavelet Analysis of the Cost-of-Carry Model," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 5(1), pages 1-17, April.
  10. Bernard Dumas, 1994. "A Test of the International CAPM Using Business Cycles Indicators as Instrumental Variables," NBER Chapters, in: The Internationalization of Equity Markets, pages 23-58 National Bureau of Economic Research, Inc.
  11. Gençay, Ramazan & Selçuk, Faruk & Whitcher, Brandon, 2001. "Differentiating intraday seasonalities through wavelet multi-scaling," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 289(3), pages 543-556.
  12. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, Econometric Society, vol. 55(2), pages 391-407, March.
  13. Ramsey James B. & Lampart Camille, 1998. "The Decomposition of Economic Relationships by Time Scale Using Wavelets: Expenditure and Income," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 3(1), pages 1-22, April.
  14. Stulz, ReneM., 1981. "A model of international asset pricing," Journal of Financial Economics, Elsevier, Elsevier, vol. 9(4), pages 383-406, December.
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