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The effect of time-varying covariances on asset risk premia |
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| Authors: | Prasad Nanisetty Rakesh Bharati Manoj Gupta |
| Institution: | (1) Nomura Securities International, 2 World Financial Center, 10281 New York, NY, USA;(2) Department of Finance, School of Business, Southern Illinois University at Edwardsville, 62026 Edwardsville, IL, USA;(3) Department of Finance, Real Estate and Decision Sciences, Barton School of Business, The Wichita State University, 67260 Wichita, KS, USA |
| Abstract: | In this article we examine an intertemporal capital asset pricing model (CAPM) that allows for time-varying conditional covariances that are assumed to follow a multivariate integrated generalized autoregressive conditional heteroscedastic (IGARCH) process. The resulting pricing equation includes idiosyncratic risk premia in addition to the usual market beta. Empirical analysis based on ten size and ten industry portfolios reveals significant idiosyncratic premia for most portfolios. Overall, we reject the static CAPM in favor of the intertemporal CAPM. |
| Keywords: | asset pricing CAPM risk return GARCH |
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