IDEAS home Printed from https://ideas.repec.org/p/ags/cudawp/127283.html
   My bibliography  Save this paper

The International CAPM When Expected Returns Are Time-Varying

Author

Listed:
  • Ng, David T.C.

Abstract

This paper derives a dynamic version of the international CAPM. The exchange-rate risk factors and intertemporal hedging factors are derived endogenously in a model that builds upon Campbell (1993). We provide a theoretical foundation for empirical risk factors often used in international asset pricing, including dividend yields, forward premia and, especially, exchange-rate indices. The model nests the standard CAPM, the international CAPM and the dynamic CAPM. Empirically, the model performs quite well in explaining average foreign-exchange and stock market returns in the US, Japan, Germany and the UK, and exchange-risk and intertemporal hedging factors play some role in pricing these assets. However, while derived in a theoretically sound fashion, these new factors are proportional to covariances with the world market portfolio. Hence, for practical purpose, the model does not perform better than the standard CAPM model. We apply the model to explain returns on portfolios of high book-to-market stocks across countries, and ̄nd that the exchange rate and intertemporal hedging factors do not help to predict these returns. Hence, they cannot account for the two-factor model proposed in Fama and French (1998).

Suggested Citation

  • Ng, David T.C., 2012. "The International CAPM When Expected Returns Are Time-Varying," Working Papers 127283, Cornell University, Department of Applied Economics and Management.
    • Handle: RePEc:ags:cudawp:127283
    DOI: 10.22004/ag.econ.127283
    as

    Download full text from publisher

    File URL: https://ageconsearch.umn.edu/record/127283/files/Cornell_Dyson_wp0212.pdf
    Download Restriction: no
    File URL: https://libkey.io/10.22004/ag.econ.127283?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    2. Bansal, Ravi & Viswanathan, S, 1993. "No Arbitrage and Arbitrage Pricing: A New Approach," Journal of Finance, American Finance Association, vol. 48(4), pages 1231-1262, September.
    3. Stephen A. Ross, 2013. "The Arbitrage Theory of Capital Asset Pricing," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 1, pages 11-30, World Scientific Publishing Co. Pte. Ltd..
    4. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    5. repec:bla:jfinan:v:53:y:1998:i:5:p:1563-1587 is not listed on IDEAS
    6. repec:bla:jfinan:v:53:y:1998:i:6:p:1975-1999 is not listed on IDEAS
    7. Yeung Lewis Chan & Leonid Kogan, 2002. "Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1255-1285, December.
    8. Jagannathan, Ravi & Wang, Zhenyu, 1996. "The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March.
    9. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
    10. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
    11. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    12. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," The Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-386.
    13. Rene M. Stulz, 1994. "International Portfolio Choice and Asset Pricing: An Integrative Survey," NBER Working Papers 4645, National Bureau of Economic Research, Inc.
    14. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
    15. Prakash Apte & Piet Sercu & Raman Uppal, 1996. "The Equilibrium Approach to Exchange Rates: Theory and Tests," NBER Working Papers 5748, National Bureau of Economic Research, Inc.
    16. Levine, Ross, 1989. "An International Arbitrage Pricing Model with PPP Deviations," Economic Inquiry, Western Economic Association International, vol. 27(4), pages 587-599, October.
    17. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    18. repec:bla:jfinan:v:44:y:1989:i:5:p:1191-1217 is not listed on IDEAS
    19. Engel, Charles, 1996. "The forward discount anomaly and the risk premium: A survey of recent evidence," Journal of Empirical Finance, Elsevier, vol. 3(2), pages 123-192, June.
    20. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-179, March.
    21. Vassalou, Maria, 2000. "Exchange Rate And Foreign Inflation Risk Premiums In Global Equity Returns," CEPR Discussion Papers 2448, C.E.P.R. Discussion Papers.
    22. Bansal, Ravi & Hsieh, David A & Viswanathan, S, 1993. "A New Approach to International Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 48(5), pages 1719-1747, December.
    23. Cumby, Robert E & Huizinga, John, 1992. "Testing the Autocorrelation Structure of Disturbances in Ordinary Least Squares and Instrumental Variables Regressions," Econometrica, Econometric Society, vol. 60(1), pages 185-195, January.
    24. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June.
    25. Harvey, Campbell R, 1991. "The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-157, March.
    26. Dumas, Bernard, 1992. "Dynamic Equilibrium and the Real Exchange Rate in a Spatially Separated World," The Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 153-180.
    27. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," The Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    28. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
    29. Adler, Michael & Dumas, Bernard, 1983. "International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-984, June.
    30. Bakshi, Gurdip S. & Naka, Atsuyuki, 1997. "An empirical investigation of asset pricing models using Japanese stock market data," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 81-112, February.
    31. Robert Hodrick & David Ng & Paul Sengmueller, 1999. "An International Dynamic Asset Pricing Model," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 597-620, November.
    32. Dumas, Bernard & Solnik, Bruno, 1995. "The World Price of Foreign Exchange Risk," Journal of Finance, American Finance Association, vol. 50(2), pages 445-479, June.
    33. Thomas J. O’Brien & Walter Dolde, 2000. "A currency index global capital asset pricing model," European Financial Management, European Financial Management Association, vol. 6(1), pages 7-18, March.
    34. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
    35. Stulz, Rene M, 1987. "An Equilibrium Model of Exchange Rate Determination and Asset Pricing with Nontraded Goods and Imperfect Information," Journal of Political Economy, University of Chicago Press, vol. 95(5), pages 1024-1040, October.
    36. De Santis, Giorgio & Gerard, Bruno, 1998. "How big is the premium for currency risk?," Journal of Financial Economics, Elsevier, vol. 49(3), pages 375-412, September.
    37. Jorion, Philippe, 1991. "The Pricing of Exchange Rate Risk in the Stock Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(3), pages 363-376, September.
    38. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    39. Bekaert, Geert & Hodrick, Robert J, 1992. "Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June.
    40. Vassalou, Maria, 2000. "Exchange rate and foreign inflation risk premiums in global equity returns," Journal of International Money and Finance, Elsevier, vol. 19(3), pages 433-470, June.
    41. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    42. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-218, March.
    43. Jiang, Wang, 1996. "The term structure of interest rates in a pure exchange economy with heterogeneous investors," Journal of Financial Economics, Elsevier, vol. 41(1), pages 75-110, May.
    44. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," The Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-566.
    45. Evans, Paul & Hasan, Iftekhar, 1998. "The consumption-based capital asset pricing model: International evidence," Journal of Multinational Financial Management, Elsevier, vol. 8(1), pages 1-21, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Shieldvie Halim & Rayenda Brahmana & Aldrin Herwany, 2011. "The Seasonality of Market Integration: The Case of Indonesia’s Stock Markets," Economics and Finance in Indonesia, Faculty of Economics and Business, University of Indonesia, vol. 59, pages 177-190, August.
    2. Tobias Adrian & Erkko Etula, 2010. "Funding liquidity risk and the cross-section of stock returns," Staff Reports 464, Federal Reserve Bank of New York.
    3. Boubakri, Salem & Couharde, Cécile & Raymond, Hélène, 2016. "Effects of financial turmoil on financial integration and risk premia in emerging markets," Journal of Empirical Finance, Elsevier, vol. 38(PA), pages 120-138.
    4. Sie Ting Lau & Lilian Ng & Bohui Zhang, 2012. "Information Environment and Equity Risk Premium Volatility Around the World," Management Science, INFORMS, vol. 58(7), pages 1322-1340, July.
    5. Tyler Muir & Erkko Etula & Tobias Adrian, 2011. "Broker-Dealer Leverage and the Cross-Section of Stock Returns," 2011 Meeting Papers 1448, Society for Economic Dynamics.
    6. Hui Guo & Christopher J. Neely & Jason Higbee, 2008. "Foreign Exchange Volatility Is Priced in Equities," Financial Management, Financial Management Association International, vol. 37(4), pages 769-790, December.
    7. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Bad Beta, Good Beta," American Economic Review, American Economic Association, vol. 94(5), pages 1249-1275, December.
    8. Moerman, Gerard A. & van Dijk, Mathijs A., 2010. "Inflation risk and international asset returns," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 840-855, April.
    9. Du, Ding & Hu, Ou, 2015. "The world market risk premium and U.S. macroeconomic announcements," Journal of International Money and Finance, Elsevier, vol. 58(C), pages 75-97.
    10. Shailesh Rana & William H. Bommer & G. Michael Phillips, 2020. "Predicting Returns for Growth and Value Stocks: A Forecast Assessment Approach Using Global Asset Pricing Models," International Journal of Economics and Financial Issues, Econjournals, vol. 10(4), pages 88-106.
    11. Balvers, Ronald J. & Klein, Alina F., 2014. "Currency risk premia and uncovered interest parity in the International CAPM," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 214-230.
    12. Lucas L. Godeiro & Bruno Ferreira Frascaroli Cassio da Nobrega Besarria & Sinezio Fernandes Maia, 2017. "International CAPM, Dynamic Betas and Optimization of Portfolios: Are countries-risk more profitable?," Journal of Statistical and Econometric Methods, SCIENPRESS Ltd, vol. 6(4), pages 1-3.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Robert Hodrick & David Ng & Paul Sengmueller, 1999. "An International Dynamic Asset Pricing Model," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 597-620, November.
    2. Lioui, Abraham & Poncet, Patrice, 2003. "International asset allocation: A new perspective," Journal of Banking & Finance, Elsevier, vol. 27(11), pages 2203-2230, November.
    3. Dahlquist, Magnus & Sallstrom, Torbjorn, 2002. "An Evaluation of International Asset Pricing Models," CEPR Discussion Papers 3145, C.E.P.R. Discussion Papers.
    4. Bernard Dumas, 1993. "Partial- vs general-equilibrium models of the international capital market," Working Papers hal-00610766, HAL.
    5. Hardouvelis, Gikas A. & Kim, Dongcheol & Wizman, Thierry A., 1996. "Asset pricing models with and without consumption data: An empirical evaluation," Journal of Empirical Finance, Elsevier, vol. 3(3), pages 267-301, September.
    6. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.
    7. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887, Elsevier.
    8. Karen K. Lewis, 2011. "Global Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 435-466, December.
    9. Doukas, John & Hall, Patricia H. & Lang, Larry H. P., 1999. "The pricing of currency risk in Japan," Journal of Banking & Finance, Elsevier, vol. 23(1), pages 1-20, January.
    10. Campbell R. Harvey & Bruno Solnik & Guofu Zhou, 2002. "What Determines Expected International Asset Returns?," Annals of Economics and Finance, Society for AEF, vol. 3(2), pages 249-298, November.
    11. Cochrane, John H., 2005. "Financial Markets and the Real Economy," Foundations and Trends(R) in Finance, now publishers, vol. 1(1), pages 1-101, July.
    12. John Y. Campbell & Yeung Lewis Chanb & M. Viceira, 2013. "A multivariate model of strategic asset allocation," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part II, chapter 39, pages 809-848, World Scientific Publishing Co. Pte. Ltd..
    13. Moerman, Gerard A. & van Dijk, Mathijs A., 2010. "Inflation risk and international asset returns," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 840-855, April.
    14. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    15. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Bad Beta, Good Beta," American Economic Review, American Economic Association, vol. 94(5), pages 1249-1275, December.
    16. Lee, Wai, 1997. "Covariance risk, consumption risk, and international stock market returns," The Quarterly Review of Economics and Finance, Elsevier, vol. 37(2), pages 491-510.
    17. Cesare Robotti, 2001. "The price of inflation and foreign exchange risk in international equity markets," FRB Atlanta Working Paper 2001-26, Federal Reserve Bank of Atlanta.
    18. Abhay Abhyankar & Angelica Gonzalez, 2007. "What Drives Corporate Bond Market Betas?," Edinburgh School of Economics Discussion Paper Series 157, Edinburgh School of Economics, University of Edinburgh.
    19. Tom A. FEARNLEY, 2002. "Estimation of an International Capital Asset Pricing Model with Stocks and Government Bonds," FAME Research Paper Series rp95, International Center for Financial Asset Management and Engineering.
    20. Clark, Ephraim & Kassimatis, Konstantinos, 2011. "An alternative measure of the "world market portfolio": Determinants, efficiency, and information content," Journal of International Money and Finance, Elsevier, vol. 30(5), pages 724-748, September.

    More about this item

    Keywords

    Risk and Uncertainty;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ags:cudawp:127283. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: AgEcon Search (email available below). General contact details of provider: https://edirc.repec.org/data/dacorus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.