On Market Price of Risk: A Global Evidence

Abstract

This abstract was created post-production by the JFI Editorial Board.

Our paper investigates the relationship between market risk premium and conditional variance and covariance in 71 capital markets, 8 regional indices, 5 block indices and the world portfolio from January 1988 to June 2001. We initially use univariate and multivariate GARCH(l,I)-M procedures to model the one-factor CAPM and allow up and downstate conditional variance and covariance to have a differential impact on risk premia. We find a linear ex-post relationship with significant upstate and downstate market price of risk and high R-squared values. Next, we investigate the cross-sections of state-dependent market price of variance and covariance risk and find evidence that market price of risk is indeed a combination of reward to local and world variance, which depends on the ever-changing integration with the world market.