Tests of International CAPM with Time-Varying Covariances

55 Pages Posted: 18 Aug 2004 Last revised: 12 Sep 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

Anthony P. Rodrigues

Federal Reserve Bank of New York

Date Written: July 1987

Abstract

We perform maximum likelihood estimation of a model of international asset pricing based on CAPM. We test the restrictions imposed by CAPM against a more general asset pricing model. The "betas" in our CAPM vary over time from two sources -- the supplies of the assets (government obligations of France, Germany, Italy, Japan, the U.K. and the U.S.) change over time, and so do the conditional covariances of returns on these assets. We let the covariances change over time as a function of macroeconomic data. We also estimate the model when the covariances follow a multivariate ARCH process. When the covariance of forecast errors are time-varying, we can identify a modified CAFM model with measurement error -- which we also estimate. We find that the model in which the CAPM restrictions are imposed (which involve cross-equation constraints between coefficients and the variances of the residuals) perform much better when variances are not constant over time. Nonetheless, the CAPM model is rejected in favor of the less restricted model of asset pricing.

Suggested Citation

Engel, Charles M. and Rodrigues, Anthony P., Tests of International CAPM with Time-Varying Covariances (July 1987). NBER Working Paper No. w2303. Available at SSRN: https://ssrn.com/abstract=347067

Charles M. Engel (Contact Author)

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

1180 Observatory Drive
Madison, WI 53706
United States
608-262-3697 (Phone)
608-262-2033 (Fax)

National Bureau of Economic Research (NBER)

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University of Washington - Department of Economics ( email )

Box 353330
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United States
206-543-6197 (Phone)
206-685-7477 (Fax)

Anthony P. Rodrigues

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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