The World Price of Covariance Risk


  • Associate Professor of Finance, Duke University, Fuqua School of Business. I have benefitted from the comments and suggestions of Andrea Beltratti, Gene Fama, Wayne Ferson, Mike Hemler, Naoki Kishimoto, Robert Korajczyk, Tom Smith, an anonymous referee and seminar participants at Duke University, the Federal Reserve Bank at Cleveland, Helsinki School of Economics, MIT, Ohio State University, Princeton University, Queen's University, Washington University and conference participants at the American Finance Association meetings, the CRSP Fall Seminar and First International Conference of the Centre for Research in Finance—IMI Group. Arthur Evans provided valuable research assistance. I am especially indebted to René Stulz who provided many insights that greatly improve this paper.


In a financially integrated global market, the conditionally expected return on a portfolio of securities from a particular country is determined by the country's world risk exposure. This paper measures the conditional risk of 17 countries. The reward per unit of risk is the world price of covariance risk. Although the tests provide evidence on the conditional mean variance efficiency of the benchmark portfolio, the results show that countries' risk exposures help explain differences in performance. Evidence is also presented which indicates that these risk exposures change through time and that the world price of covariance risk is not constant.