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Asset pricing with a factor-arch covariance structure : Empirical estimates for treasury bills

  • Engle, Robert F.
  • Ng, Victor K.
  • Rothschild, Michael

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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Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 45 (1990)
Issue (Month): 1-2 ()
Pages: 213-237

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Handle: RePEc:eee:econom:v:45:y:1990:i:1-2:p:213-237
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