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Conditional Mean-Variance Efficiency of the U.S. Stock Market

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  • Charles Engel
  • Jeffrey A. Frankel
  • Kenneth A. Froot
  • Anthony P. Rodrigues

Abstract

We apply the method of constrained asset share estimation (CASE) to test the mean-variance efficiency (MVE) of the stock market. This method allows conditional expected returns to vary in unrestricted ways, given investor preferences. We also allow conditional variances to follow an ARCH process. The data estimate reasonably the coefficient of relative risk aversion, though are unable to reject investor risk neutrality. We reject the restrictions implied by MVE, although changing conditional variances improve statistically upon measured market efficiency. We find that unrestricted asset-share and ARCH models help forecast excess returns. Once MVE is imposed, however, this forecasting ability disappears.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2890.

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Date of creation: Mar 1989
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Publication status: published as "Tests of Conditional Mean-Variance Efficiency of the US Stock Market," Journal of Emprirical Financial, March 2, 1995 (revised)
Handle: RePEc:nbr:nberwo:2890

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  1. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(2), pages 246-73, April.
  2. E.K. Berndt & B.H. Hall & R.E. Hall, 1974. "Estimation and Inference in Nonlinear Structural Models," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 3, number 4, pages 103-116 National Bureau of Economic Research, Inc.
  3. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  4. Gibbons, Michael R. & Shanken, Jay, 1987. "Subperiod aggregation and the power of multivariate tests of portfolio efficiency," Journal of Financial Economics, Elsevier, Elsevier, vol. 19(2), pages 389-394, December.
  5. Shanken, Jay, 1985. "Multivariate tests of the zero-beta CAPM," Journal of Financial Economics, Elsevier, Elsevier, vol. 14(3), pages 327-348, September.
  6. Robert Stambaugh, . "On the Exclusion of Assets from Tests of the Two-Parameter Model: A Sensitivity Analysis," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 13-81, Wharton School Rodney L. White Center for Financial Research.
  7. Anthony Rodrigues & Charles Engel, 1988. "A test of international CAPM," Research Paper, Federal Reserve Bank of New York 8822, Federal Reserve Bank of New York.
  8. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, Econometric Society, vol. 57(5), pages 1121-52, September.
  9. 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.
  10. Jeffrey A. Frankel and William T. Dickens., 1983. "Are Asset-Demand Functions Determined by CAPM?," Research Program in Finance Working Papers, University of California at Berkeley 140, University of California at Berkeley.
  11. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
  12. Jeffrey A. Frankel & Charles Engel, 1982. "Do Asset-Demand Functions Optimize over the Mean and Variance of Real Returns? A Six-Currency Test," NBER Working Papers 1051, National Bureau of Economic Research, Inc.
  13. Engel, Charles & Rodrigues, Anthony P, 1989. "Tests of International CAPM with Time-Varying Covariances," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 4(2), pages 119-38, April-Jun.
  14. Frankel, Jeffrey A., 1982. "In search of the exchange risk premium: A six-currency test assuming mean-variance optimization," Journal of International Money and Finance, Elsevier, Elsevier, vol. 1(1), pages 255-274, January.
  15. Hansen, Lars Peter & Richard, Scott F, 1987. "The Role of Conditioning Information in Deducing Testable," Econometrica, Econometric Society, Econometric Society, vol. 55(3), pages 587-613, May.
  16. Bollerslev, Tim, 1987. "A Conditionally Heteroskedastic Time Series Model for Speculative Prices and Rates of Return," The Review of Economics and Statistics, MIT Press, vol. 69(3), pages 542-47, August.
  17. Ferson, Wayne E & Kandel, Shmuel & Stambaugh, Robert F, 1987. " Tests of Asset Pricing with Time-Varying Expected Risk Premiums and Market Betas," Journal of Finance, American Finance Association, American Finance Association, vol. 42(2), pages 201-20, June.
  18. Schwert, G. William, 1983. "Size and stock returns, and other empirical regularities," Journal of Financial Economics, Elsevier, Elsevier, vol. 12(1), pages 3-12, June.
  19. MacKinlay, A. Craig, 1987. "On multivariate tests of the CAPM," Journal of Financial Economics, Elsevier, Elsevier, vol. 18(2), pages 341-371, June.
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Cited by:
  1. Bekaert, Geert & Wu, Guojun, 2000. "Asymmetric Volatility and Risk in Equity Markets," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 13(1), pages 1-42.
  2. Tim BOLLERSLEV & Ray Y. CHOU & Narayanan JAYARAMAN & Kenneth F. KRONER, 1991. "Les modéles ARCH en finance : un point sur la théorie et les résultats empiriques," Annales d'Economie et de Statistique, ENSAE, issue 24, pages 1-59.
  3. Joyce, Michael & Lasaosa, Ana & Stevens , Ibrahim & Tong, Matthew, 2010. "The financial market impact of quantitative easing," Bank of England working papers 393, Bank of England.
  4. David Morelli, 2003. "Capital asset pricing model on UK securities using ARCH," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 13(3), pages 211-223.
  5. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, Elsevier, vol. 52(1-2), pages 5-59.

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