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The International CAPM When Expected Returns Are Time-Varying

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  • Ng, David T.C.

Abstract

This paper derives a dynamic version of the international CAPM. The exchange-rate risk factors and intertemporal hedging factors are derived endogenously in a model that builds upon Campbell (1993). We provide a theoretical foundation for empirical risk factors often used in international asset pricing, including dividend yields, forward premia and, especially, exchange-rate indices. The model nests the standard CAPM, the international CAPM and the dynamic CAPM. Empirically, the model performs quite well in explaining average foreign-exchange and stock market returns in the US, Japan, Germany and the UK, and exchange-risk and intertemporal hedging factors play some role in pricing these assets. However, while derived in a theoretically sound fashion, these new factors are proportional to covariances with the world market portfolio. Hence, for practical purpose, the model does not perform better than the standard CAPM model. We apply the model to explain returns on portfolios of high book-to-market stocks across countries, and ̄nd that the exchange rate and intertemporal hedging factors do not help to predict these returns. Hence, they cannot account for the two-factor model proposed in Fama and French (1998).

Suggested Citation

  • Ng, David T.C., 2012. "The International CAPM When Expected Returns Are Time-Varying," Working Papers 127283, Cornell University, Department of Applied Economics and Management.
  • Handle: RePEc:ags:cudawp:127283
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    Cited by:

    1. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Bad Beta, Good Beta," American Economic Review, American Economic Association, vol. 94(5), pages 1249-1275, December.
    2. Hui Guo & Christopher J. Neely & Jason Higbee, 2008. "Foreign Exchange Volatility Is Priced in Equities," Financial Management, Financial Management Association International, vol. 37(4), pages 769-790, December.
    3. Tobias Adrian & Erkko Etula, 2010. "Funding liquidity risk and the cross-section of stock returns," Staff Reports 464, Federal Reserve Bank of New York.
    4. Moerman, Gerard A. & van Dijk, Mathijs A., 2010. "Inflation risk and international asset returns," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 840-855, April.
    5. Boubakri, Salem & Couharde, Cécile & Raymond, Hélène, 2016. "Effects of financial turmoil on financial integration and risk premia in emerging markets," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 120-138.
    6. Sie Ting Lau & Lilian Ng & Bohui Zhang, 2012. "Information Environment and Equity Risk Premium Volatility Around the World," Management Science, INFORMS, vol. 58(7), pages 1322-1340, July.
    7. 1Shieldvie Halim Author_Email: & Aldrin Herwany, & Rayenda Brahmana, 2011. "The Seasonality Of Market Integration: Case Of Indonesian Stock Markets," 2nd International Conference on Business and Economic Research (2nd ICBER 2011) Proceeding 2011-439, Conference Master Resources.
    8. Tyler Muir & Erkko Etula & Tobias Adrian, 2011. "Broker-Dealer Leverage and the Cross-Section of Stock Returns," 2011 Meeting Papers 1448, Society for Economic Dynamics.
    9. Du, Ding & Hu, Ou, 2015. "The world market risk premium and U.S. macroeconomic announcements," Journal of International Money and Finance, Elsevier, vol. 58(C), pages 75-97.
    10. Balvers, Ronald J. & Klein, Alina F., 2014. "Currency risk premia and uncovered interest parity in the International CAPM," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 214-230.
    11. repec:spt:stecon:v:6:y:2017:i:4:f:6_4_3 is not listed on IDEAS

    More about this item

    Keywords

    International CAPM; dynamic asset pricing; exchange rate risk; intertem- poral hedging; Risk and Uncertainty; G12; G15;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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