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The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets

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  • Giovannini, Alberto

Abstract

Recent empirical work indicates that, in a variety of financial markets, both conditional expectations and conditional variances of asset returns are time-varying. The purpose of this paper is to determine whether these joint fluctuations of conditional first and second moments are consistent with the Sharpe-Lintner-Mossin capital-asset-pricing model (CAPM). We test the mean-variance model under several different assumptions about the time-variation of conditional second moments of returns, using weekly data from July 1974 to December 1986 on returns to a portfolio composed of dollar, Deutschmark, sterling, and Swiss franc assets, together with United States equities. The model is estimated constraining risk premia to depend on the time-varying conditional covariance matrix of the residuals of the expected returns equations. The results indicate that estimated conditional variances cannot explain the observed time-variation of risk premia. Furthermore, the constraints imposed by the static CAPM are always rejected.

Suggested Citation

  • Giovannini, Alberto, 1988. "The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets," CEPR Discussion Papers 228, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:228
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    Cited by:

    1. Frankel, Jeffrey & Phillips, Steven, 1992. "The European Monetary System: Credible at Last?," Oxford Economic Papers, Oxford University Press, vol. 44(4), pages 791-816, October.
    2. Jeff Frankel, Steve Phillips, and Menzie Chinn., 1992. "Financial and Currency Integration in the European Monetary System: The Statistical Record," Center for International and Development Economics Research (CIDER) Working Papers C92-005, University of California at Berkeley.
    3. Knot, Klaas & de Haan, Jakob, 1995. "Interest rate differentials and exchange rate policies in Austria, The Netherlands, and Belgium," Journal of Banking & Finance, Elsevier, vol. 19(2), pages 363-386, May.

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