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Testing the conditional CAPM using multivariate GARCH-M

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  • Bjorn Hansson
  • Peter Hordahl

Abstract

The relation between expected return and time varying risk on the Swedish stock market for the period 1977 to 1990 is examined. Using a parsimonious multivariate GARCH-M model, the conditional Sharpe - Lintner - Mossin CAPM is tested against six alternative hypotheses, including the zero-beta version of CAPM, a conditional residual risk model, and models which nest the international CAPM and the consumption CAPM. The hypotheses are tested using beta-ranked, size-ranked, and industry-sorted portfolios. The estimates for the null hypothesis show that the price of risk is positive and significant for all portfolio groupings. Using robust LM-tests, the null hypothesis cannot be rejected in favour of any of the alternative hypotheses. In contrast to international evidence, where the traditional CAPM very often is rejected in favour of asset pricing models that rely on more general measures of risk, these results provide strong support for the Sharpe - Lintner - Mossin version of the conditional CAPM.

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  • Bjorn Hansson & Peter Hordahl, 1998. "Testing the conditional CAPM using multivariate GARCH-M," Applied Financial Economics, Taylor & Francis Journals, vol. 8(4), pages 377-388.
    • Handle: RePEc:taf:apfiec:v:8:y:1998:i:4:p:377-388
    DOI: 10.1080/096031098332916
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    2. Martin Scheicher, 2000. "Time-varying risk in the German stock market," The European Journal of Finance, Taylor & Francis Journals, vol. 6(1), pages 70-91.
    3. Morelli, David, 2011. "Joint conditionality in testing the beta-return relationship: Evidence based on the UK stock market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(1), pages 1-13, February.
    4. 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.
    5. 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.
    6. Noureddine Benlagha, 2014. "Volatility Linkage of Nominal and Index-linked Bond Returns: A Multivariate BEKK-GARCH Approach," Review of Economics & Finance, Better Advances Press, Canada, vol. 4, pages 49-60, November.
    7. de Almeida, Daniel & Hotta, Luiz K. & Ruiz, Esther, 2018. "MGARCH models: Trade-off between feasibility and flexibility," International Journal of Forecasting, Elsevier, vol. 34(1), pages 45-63.
    8. Su, EnDer, 2013. "Stock index hedge using trend and volatility regime switch model considering hedging cost," MPRA Paper 49190, University Library of Munich, Germany.
    9. Muhammad Hanif & Abdullah Iqbal & Zulfiqar Shah, 2016. "Risk and Returns of Sharīʿah Compliant Stocks on the Karachi Stock Exchange – A CAPM and SCAPM Approach المخاطر والعوائد في مقطع عرضي من الأسهم المتوافقة مع الشريعة: اختبار متانة التطبيق وعيوب نموذج ت," Journal of King Abdulaziz University: Islamic Economics, King Abdulaziz University, Islamic Economics Institute., vol. 29(2), pages 37-54, January.
    10. Noureddine Benlagha, 2014. "Dependence structure between nominal and index-linked bond returns: a bivariate copula and DCC-GARCH approach," Applied Economics, Taylor & Francis Journals, vol. 46(31), pages 3849-3860, November.
    11. Su, EnDer, 2014. "Measuring Contagion Risk in High Volatility State between Major Banks in Taiwan by Threshold Copula GARCH Model," MPRA Paper 58161, University Library of Munich, Germany.
    12. Chee Wooi Hooy & Hui Boon Tan & Annuar Md Nassir, 2004. "Risk Sensitivity of Bank Stocks in Malaysia: Empirical Evidence Across the Asian Financial Crisis," Asian Economic Journal, East Asian Economic Association, vol. 18(3), pages 261-276, September.
    13. Slim Mseddi & Noureddine Benlagha, 2017. "An Analysis of Spillovers Between Islamic and Conventional Stock Bank Returns: Evidence from the GCC Countries," Multinational Finance Journal, Multinational Finance Journal, vol. 21(2), pages 91-132, June.
    14. David Morelli, 2003. "Capital asset pricing model on UK securities using ARCH," Applied Financial Economics, Taylor & Francis Journals, vol. 13(3), pages 211-223.
    15. Wang, Lu, 2021. "Time-varying conditional beta, return spillovers, and dynamic bank diversification strategies," The Quarterly Review of Economics and Finance, Elsevier, vol. 79(C), pages 272-280.
    16. Jin Zhang & Dietmar Maringer, 2010. "Asset Pair-Copula Selection with Downside Risk Minimization," Working Papers 037, COMISEF.
    17. Anders Johansson, 2009. "Stochastic volatility and time-varying country risk in emerging markets," The European Journal of Finance, Taylor & Francis Journals, vol. 15(3), pages 337-363.
    18. EnDer Su, 2017. "Measuring and Testing Tail Dependence and Contagion Risk Between Major Stock Markets," Computational Economics, Springer;Society for Computational Economics, vol. 50(2), pages 325-351, August.
    19. Su, EnDer, 2017. "Stock index hedging using a trend and volatility regime-switching model involving hedging cost," International Review of Economics & Finance, Elsevier, vol. 47(C), pages 233-254.
    20. Silvennoinen, Annastiina & Teräsvirta, Timo, 2007. "Multivariate GARCH models," SSE/EFI Working Paper Series in Economics and Finance 669, Stockholm School of Economics, revised 18 Jan 2008.
    21. Gómez-Déniz, E., 2004. "A note on mixture prior distributions with applications in actuarial statistic/Sobre las Distribuciones a Priori Mixtas con Aplicaciones en la Estadística Actuarial," Estudios de Economia Aplicada, Estudios de Economia Aplicada, vol. 22, pages 372(15á)-37, Agosto.
    22. Chevapatrakul, Thanaset, 2013. "Return sign forecasts based on conditional risk: Evidence from the UK stock market index," Journal of Banking & Finance, Elsevier, vol. 37(7), pages 2342-2353.

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