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Macroeconomic shocks and the CAPM: evidence from the UK stockmarket
Author(s) -
Clare Andrew,
O’Brien Raymond,
Thomas Stephen,
Wickens Michael
Publication year - 1998
Publication title -
international journal of finance and economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.505
H-Index - 39
eISSN - 1099-1158
pISSN - 1076-9307
DOI - 10.1002/(sici)1099-1158(199804)3:2<111::aid-ijfe70>3.0.co;2-l
Subject(s) - economics , econometrics , capital asset pricing model , conditional variance , equity (law) , null hypothesis , stock market , bond , financial economics , stock (firearms) , arch , autoregressive conditional heteroskedasticity , volatility (finance) , finance , mechanical engineering , paleontology , civil engineering , horse , political science , law , biology , engineering
The UK stockmarket is tested for mean variance efficiency (MVE) in the sense that sectoral stock returns satisfy the restrictions implied by CAPM. There are two main innovations in the paper. One is the use of a model for excess returns in which the conditional covariance matrix of returns varies over time due to the simultaneous influence of four macroeconomic shocks. The other is the use of a likelihood ratio test for MVE calculated from analytical derivatives of the likelihood function in order to reduce the computational burden of these high parameter dimensional models. The model with macroeconomic shocks is compared with the multivariate ARCH‐in‐mean model. Although the macroeconomic shocks model is found to perform slightly better than the ARCH model, and both produce a significant and plausible estimate of the coefficient of risk aversion, the null hypothesis that the UK stockmarket is mean variance efficient is rejected for both models in favour of the alternative hypothesis that equity returns are an unrestricted linear function of asset shares. Another important finding is that the most important shocks affecting the UK stockmarket either have an international origin or are due to the bond market. © 1998 John Wiley & Sons, Ltd.