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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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Paper provided by Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes in its series SFB 373 Discussion Papers with number 1999,22.

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Date of creation: 1999
Date of revision:
Handle: RePEc:zbw:sfb373:199922
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  1. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
  2. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
  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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