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A variance equality test of the ICAPM on Philippine stocks: post-Asian financial crisis period

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Abstract:

The study examines whether Fama's discrete version of Merton's intertemporal CAPM (ICAPM) can explain the negative market risk premium and the cross-sectional variability of Philippine stock returns after the onset of the Asian financial crisis in July 1997. The change in foreign exchange rate, in addition to the change in market risk premium, is used as a state variable of hedging concern to investors. The relationship of Fama's multifactor minimum-variance (MMV) portfolio to the Markowitz minimum-variance (MV) portfolio is characterized in terms of the equality of the return variances for the same expected return. A test due to Basak et al. (2002) is then used to verify the equality of the return variance of a derived tangency portfolio along the MMV frontier to an MV portfolio with the same sample mean return. The results do not reject the ICAPM during the period covered by the study. Thus, the model provides a plausible explanation both for the cross-sectional variability of stock returns and the negative market risk premium within the framework of mean-variance optimizing investors.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840500368854

Affiliations: College of Business Administration, University of the Philippines, Diliman, Quezon City, Philippines

Publication date: February 20, 2006

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