International CAPM: Why Has it Failed?
Previous empirical studies of international CAPM models have not found much evidence to support the model. In this paper we suggest reasons why this might have happened and perform new tests using improved models and data. A range of monthly CAPM models are estimated for 1973-87 for aggregate equities and bonds in Germany, Japan, the United States and United Kingdom. The models are an improvement on earlier work in that we integrate equity markets into the analysis instead of focusing exclusively on government bond stocks, and we carefully measure the rates of return for both bonds and equities. In particular, bond returns reflect changes in the price of bonds as well as coupons. Despite this wider portfolio and the introduction of ARCH effects in the conditional covariance matrix of errors, our model still yields implausible estimates of the coefficient of relative risk aversion and provides very little explanatory power for expected relative rates of return. Correcting the ICAPM for these major deficiencies does not reverse earlier conclusions in the literature.
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