NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

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

Alberto Giovannini, Philippe Jorion

NBER Working Paper No. 2573 (Also Reprint No. r1321)
Issued in November 1989
NBER Program(s):   ITI   IFM

Recent empirical work indicates that, in a variety of financial markets, both conditional expectations and conditional variances of 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. 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, that include returns on a portfolio composed of dollar, Deutsche mark, Sterling, and Swiss franc assets, together with the US stock market. 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 CAPH are always rejected.

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Published: The Journal of Finance, Vol. XLIV, No. 2, pp. 307-325, (June 1989).

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