Conditional Mean-Variance Efficiency of the U.S. Stock Market

26 Pages Posted: 29 Nov 2001 Last revised: 15 Dec 2008

See all articles by Charles M. Engel

Charles M. Engel

University of Wisconsin - Madison - Department of Economics; National Bureau of Economic Research (NBER); University of Washington - Department of Economics

Jeffrey A. Frankel

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Kenneth Froot

National Bureau of Economic Research (NBER); Harvard University - Business School (HBS)

Anthony P. Rodrigues

Federal Reserve Bank of New York

Date Written: March 1989

Abstract

We apply the method of constrained asset share estimation (CASE) to test the mean-variance efficiency (MVE) of the stock market. This method allows conditional expected returns to vary in unrestricted ways, given investor preferences. We also allow conditional variances to follow an ARCH process. The data estimate reasonably the coefficient of relative risk aversion, though are unable to reject investor risk neutrality. We reject the restrictions implied by MVE, although changing conditional variances improve statistically upon measured market efficiency. We find that unrestricted asset-share and ARCH models help forecast excess returns. Once MVE is imposed, however, this forecasting ability disappears.

Suggested Citation

Engel, Charles M. and Frankel, Jeffrey A. and Froot, Kenneth and Rodrigues, Anthony P., Conditional Mean-Variance Efficiency of the U.S. Stock Market (March 1989). NBER Working Paper No. w2890. Available at SSRN: https://ssrn.com/abstract=292511

Charles M. Engel (Contact Author)

University of Wisconsin - Madison - Department of Economics ( email )

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University of Washington - Department of Economics ( email )

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Jeffrey A. Frankel

Harvard University - Harvard Kennedy School (HKS) ( email )

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National Bureau of Economic Research (NBER)

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Kenneth Froot

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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Harvard University - Business School (HBS) ( email )

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Boston, MA 02163
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Anthony P. Rodrigues

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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