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Asset Pricing with a Factor Arch Covariance Structure: Empirical Estimates for Treasury Bills

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  • Robert F. Engle
  • Victor Ng
  • Michael Rothschild

Abstract

Asset pricing relations are developed for a vector of assets with a time varying covariance structure. Assuming that the eigenvectors are constant but the eigenvalues changing, both the Capital Asset Pricing Model and the Arbitrage Pricing Theory suggest the same testable implication: the time varying part of risk premia are proportional to the time varying eigenvalues. Specifying the eigenvalues as general ARCH processes. the model is a multivariate Factor ARCH model. Univariate portfolios corresponding to the eigenvectors will have (time varying) risk premia proportional to their own (time varying) variance and can be estimated using the GARCH-M model. This structure is applied to monthly treasury bills from two to twelve months maturity and the value weighted NYSE returns index. The bills appear to have a single factor in the variance process and this factor is influenced or "caused in variance" by the stock returns.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0065.

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Date of creation: Nov 1988
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Publication status: published as Journal of Econometrics, Vol. 45, No. 1/2, pp. 213-237, (July/August 1990).
Handle: RePEc:nbr:nberte:0065

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