*I want to thank Tom Smith, Tim Brailsford, Guo Hui, Michael Lemmon (editor), Hong Yongmiao, Jiang Yan-Fei, Sam Richie, two anonymous referees and participants of 2009 Asian Finance Association annual conference (Brisbane) for helpful comments. The usual disclaimer applies.
Market Price of Risk: A Comparison among the United States, United Kingdom, Australia and Japan*
Article first published online: 2 DEC 2009
© 2009 The Authors. Journal compilation © International Review of Finance Ltd. 2009
International Review of Finance
Volume 9, Issue 4, pages 405–429, December 2009
How to Cite
WANG, K. (2009), Market Price of Risk: A Comparison among the United States, United Kingdom, Australia and Japan. International Review of Finance, 9: 405–429. doi: 10.1111/j.1468-2443.2009.01098.x
- Issue published online: 2 DEC 2009
- Article first published online: 2 DEC 2009
This study examines and compares the market price of risk of the S&P 500, FTSE 100, All Ordinaries, and Nikkei 225 markets from 1984 to 2009 in the framework of Intertemporal Capital Asset Pricing Model (ICAPM). We follow the Vector Autoregressive instrumental variable approach in identifying the risk and hedge components of market returns and argue that in the context of market integration, covariance with a world market portfolio is a better measure of market risk than conditional market variance. Evidence is documented in support of using covariance as a risk measure in explaining market risk premiums in the Australian and Japanese markets. CAY, the consumption wealth ratio from the US market is found to be a robust state variable that helps to explain both conditional variance and covariance processes in the four markets. The market prices of risk, after controlling for the hedging demands, are positive and significant with the United States having the highest price of risk. The results are confirmed using a series of robustness tests that include varying the sampling interval.