How Do the Time-Varying Risk Prices Behave in Japan? An Investigation with a Multivariate GARCH-CAPM Approach

Abstract

This paper examines the pricing of month-by-month time-varying risks on the Japanese stock market over the pe- riod from 1981 to 2004. Using the multivariate GARCH model, we tested the conditional version of the Sharpe-Lintner- Mossin CAPM. In contrast to previous studies, we derive and focus strictly on the monthly time-varying risk prices while employing the Fama and French approach by constructing 25 size-ranked and 25 BE/ME-ranked portfolio returns. The em- pirical results show that the price of risk in the conditional version of the Sharpe-Lintner-Mossin CAPM is generally positive and significant when the time-varying covariances from the multivariate GARCH model are used. This provides evidence contrary to the findings of many international studies in which the validity of the traditional CAPM is very often denied.