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International CAPM with Regime Switching GARCH Parameters

Author

Listed:
  • Lorenzo CAPPIELLO

    (Graduate Institute of International Studies, University of Geneva, Switzerland)

  • Tom A. Fearnley

    (Graduate Institute of International Studies, University of Geneva;International Center fo Financial Asset Management and Engineering (FAME), Geneva Switzerland; Central Bank of Norway, Oslo)

Abstract

This paper tests a conditional version of Adler and Dumas'(1983) International CAPM with regime switching GARCH parameters. As benchmark the same model is estimated without state dependent parameters. The switching representation is found to react faster than the benchmark to shocks in stock market returns. This suggests that the non-switching model suffers from spuriously high persistence. In particular, when a financial crisis occurs, the conditional risk exposures appear to be underestimated, while overestimated in the aftermath. The introduction of a regime switching model should hence improve forecasting power. We also find that in periods of financial turmoil, weight is shifting from the GARCH, towards the ARCH termes of the conditional covariance generating process. During such events investors, when formin their (co)variance expectations, seem to put more emphasis on current shocks, at the expense of the current second moments.

Suggested Citation

  • Lorenzo CAPPIELLO & Tom A. Fearnley, 2000. "International CAPM with Regime Switching GARCH Parameters," FAME Research Paper Series rp17, International Center for Financial Asset Management and Engineering.
  • Handle: RePEc:fam:rpseri:rp17
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    File URL: http://www.swissfinanceinstitute.ch/rp17.pdf
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    Citations

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    Cited by:

    1. Enrique Salvador, 2012. "The Risk-Return Trade-Off in Emerging Markets," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 48(6), pages 106-128, November.
    2. Buckley, Ian & Saunders, David & Seco, Luis, 2008. "Portfolio optimization when asset returns have the Gaussian mixture distribution," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1434-1461, March.
    3. Enrique Salvador, 2012. "The Risk-Return Trade-Off in Emerging Markets," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 48(6), pages 106-128, November.
    4. Francesco Giurda & Elias Tzavalis, 2004. "Is the Currency Risk Priced in Equity Markets?," Working Papers 511, Queen Mary University of London, School of Economics and Finance.
    5. Salvador, Enrique & Floros, Christos & Arago, Vicent, 2014. "Re-examining the riskÔÇôreturn relationship in Europe: Linear or non-linear trade-off?," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 60-77.
    6. 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; Multivariate GARCH-in-Mean; Regime Switching;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • 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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