Country and Industry Equity Risk Premia in the Euro Area: An Intertemporal Approach

45 Pages Posted: 24 Mar 2008 Last revised: 2 Jul 2008

See all articles by Lorenzo Cappiello

Lorenzo Cappiello

European Central Bank (ECB)

Marco Lo Duca

European Central Bank (ECB)

Angela Maddaloni

European Central Bank (ECB)

Date Written: June 1, 2008

Abstract

This paper provides new evidence on the dynamics of equity risk premia in euro area stock markets across country and industry portfolios. We develop and estimate a conditional intertemporal CAPM where returns on aggregate euro area, country and industry portfolios depend on the market risk as well as on the risk that the investment opportunity set changes over time. Prices of risks are time-varying, according to a Kalman filter approach. We find that both market and intertemporal risks are significantly priced. When we include country and industry-specific risk factors they turn out to be not significantly priced for most industries, suggesting that euro area equity markets are well integrated. Overall, the analysis indicates that omitting the intertemporal factor leads to mispricing and misleading conclusions regarding the degree of financial integration across sectors and countries.

Keywords: conditional asset pricing, intertemporal risk, financial integration, multivariate GARCH, Kalman filter

JEL Classification: G12, F37, C32

Suggested Citation

Cappiello, Lorenzo and Lo Duca, Marco and Maddaloni, Angela, Country and Industry Equity Risk Premia in the Euro Area: An Intertemporal Approach (June 1, 2008). ECB Working Paper No. 913, Available at SSRN: https://ssrn.com/abstract=1108311

Lorenzo Cappiello

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 8765 (Phone)

Marco Lo Duca

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Angela Maddaloni (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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