Intertemporal risk–return relationship in the Asian markets around the Asian crisis

Abstract

This study investigates the risk–return relationship in nine Asian capital markets and the U.S. before, during, and after the Asian financial crisis. Using a state-dependent approach in a TGARCH(1,1)-M framework, we investigate a contemporaneous version of the CAPM by accounting for negative and positive market price of variance risk. We find a significant positive relationship between risk premium and variance in all markets in upstate, as well as a significant negative relationship in downstate. Also, we validate our findings by showing that implied state-dependent market prices of variance risk explain risk premia across markets. Finally, we investigate how the model can be used to uncover overreaction and improve the number of correct directional calls in a tactical asset allocation strategy. Our results provide support for a contrarian strategy that individual investors can follow.