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Time-varying market price of risk in the CAPM: Approaches, empirical evidence and implications


  • Hafner, Christian M.
  • Herwartz, Helmut


Time-varying risk premia traditionally have been associated with the empirical fact that conditional second moments are time-varying. This paper additionally examines another possible source for time-varying risk premia, namely the market price of risk (lambda). For utility functions that do not imply constant risk aversion measures, the market price of risk will in general change over time. We provide empirical evidence for the German stock market in a bivariate GARCH-M framework using alternative specifications for lambda. The results indicate that a model with lambda being a function of typical volatility measures performs best for most series. To facilitate the interpretation of the results, we plot impulse response functions of the risk premia.

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  • Hafner, Christian M. & Herwartz, Helmut, 1999. "Time-varying market price of risk in the CAPM: Approaches, empirical evidence and implications," SFB 373 Discussion Papers 1999,22, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
  • Handle: RePEc:zbw:sfb373:199922

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    References listed on IDEAS

    1. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
    2. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    3. Koop, Gary & Pesaran, M. Hashem & Potter, Simon M., 1996. "Impulse response analysis in nonlinear multivariate models," Journal of Econometrics, Elsevier, vol. 74(1), pages 119-147, September.
    4. Braun, Phillip A & Nelson, Daniel B & Sunier, Alain M, 1995. " Good News, Bad News, Volatility, and Betas," Journal of Finance, American Finance Association, vol. 50(5), pages 1575-1603, December.
    5. Baillie, Richard T. & Bollerslev, Tim & Mikkelsen, Hans Ole, 1996. "Fractionally integrated generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 74(1), pages 3-30, September.
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    Cited by:

    1. Massimiliano Caporin & Michael McAleer, 2011. "Thresholds, news impact surfaces and dynamic asymmetric multivariate GARCH," Statistica Neerlandica, Netherlands Society for Statistics and Operations Research, vol. 65(2), pages 125-163, May.
    2. Anton Andriyashin & Wolfgang Härdle & Roman Timofeev, 2008. "Recursive Portfolio Selection with Decision Trees," SFB 649 Discussion Papers SFB649DP2008-009, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    3. Sébastien Laurent & Luc Bauwens & Jeroen V. K. Rombouts, 2006. "Multivariate GARCH models: a survey," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 79-109.
    4. repec:eee:phsmap:v:482:y:2017:i:c:p:638-648 is not listed on IDEAS
    5. Schrimpf, Andreas & Schröder, Michael & Stehle, Richard, 2006. "Evaluating conditional asset pricing models for the German stock market," ZEW Discussion Papers 06-043, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.


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