Abstract
This paper evaluates conditional asset pricing models for the Japanese stock market by examining time-varying risk pricing. Using a multivariate generalized autoregressive conditional heteroskedasticity (GARCH) model, we tested the conditional versions of the Sharpe (1964)−Lintner (1965)−Mossin (1966) capital asset pricing model (CAPM), the consumption CAPM (CCAPM), and the CAPM with a constant term. The empirical results demonstrate that the price of risk in the conditional CAPM is generally positive and significant. Moreover, our formal panel data tests reveal that the conditional CAPM is never rejected in the case of the 25 book-equity-to-market equity (BE/ME)-ranked portfolios. Furthermore, in the conditional version of the CAPM with a constant term, positive alphas are generally seen in Japan; however, our statistical test of the hypothesis that the average value of the alphas of the conditional CAPM equals zero is never rejected for the 25 BE/ME-ranked portfolios in Japan. This evidence demonstrates that the CAPM can be adequately represented by using the multivariate GARCH model to explain the value premia in Japan.
Highlights
The time-varying characteristics of both covariance risk and the price of risk are clearly crucial for asset pricing
We implement three types of formal F-tests on a monthly basis.(Note 15) For the three F-tests, the tested period is from January 1982 to December 2003, the conditional time-varying covariances derived from the multivariate generalized autoregressive conditional heteroskedasticity (GARCH) model are used, and the same data set of 25 size and book-equity-to-market equity (BE/ME) portfolios are again used
The conditional time-varying covariances derived from the multivariate GARCH model are used for the tests
Summary
The time-varying characteristics of both covariance risk and the price of risk are clearly crucial for asset pricing. Research on asset pricing focusing on the time-varying risk price rather than on time-varying risk is required. Our second motive relates to the ongoing debate regarding the conditional CAPM and the conditional consumption-based CAPM (CCAPM) Some authors, such as Jagannathan and Wang (1996), Lettau and Ludvigson (2001), Ang and Chen (2007), and Petkova and Zhang (2005), find that conditional models help explain the cross-section of stock returns. It is pointed out that the testing methodologies that the above studies employ are not always the same, the Generalized Method of Moments (GMM) approach is typical This situation requires additional research as to the effectiveness of conditional asset pricing models using methods other than the typical GMM approach
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