Changing Risk Premia: Evidence from a Small Open Economy

Abstract

Little is known about the differences in the relation between risk and return in large economies such as the U.S. compared with smaller, less studied, markets. In this paper, Sweden serves as a representative for small open economies. The price of risk on the Swedish stock market is estimated using a conditional asset pricing model that allows for time variation in the risk. Four different GARCH‐M models are used in the econometric specification. The estimates of the price of risk are invariably positive and significant, and we conclude that there exists a time‐varying risk premium in the Swedish stock market. Our results show that there are small differences in the preferences towards risk of representative investors in small and large economies.