Article1996

Macrofactor Conditional Volatilities, Time‐Varying Risk Premia and Stock Return Behavior

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Financial Markets and Investment Strategies Financial Analysis and Corporate Governance Financial Risk and Volatility Modeling

Abstract

Abstract An Arbitrage Pricing Model is estimated in which the risk premia vary in proportion to the conditional volatilities of the macroeconomic innovations which follow an autoregressive specification. The conditional volatilities of the macroeconomic innovations exhibit strong timevariation from month to month. For size‐ranked portfolios of all the shares traded on the Toronto Stock Exchange over the period from March 1962 through March 1988, five macrofactors (namely, the lag of industrial production, the Canadian index of 10 leading indicators, the U.S. composite index of 12 leading indicators, the exchange rate and the residual market factor) have time‐varying and priced risk premia. The small‐firm effect is absent in the risk‐adjusted returns, and a significant portion of the observed January seasonality is explained by the model with time‐varying risk premia.

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References

1973Risk, Return, and Equilibrium: Empirical Tests 1985A Theory of the Term Structure of Interest Rates 1976The arbitrage theory of capital asset pricing 1973An Intertemporal Capital Asset Pricing Model 1986Economic Forces and the Stock Market 1989Why Does Stock Market Volatility Change Over Time?1977A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory 1980On estimating the expected return on the market

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