An Evaluation of International Asset Pricing Models
38 Pages Posted: 1 Apr 2002
Date Written: May 15, 2002
This paper assesses the ability of international asset pricing models to explain the cross-sectional variation in expected returns. All the models considered seem to capture national market returns fairly well. However, global portfolios, sorted on earnings-price ratio and market value, pose a special challenge. We find that an unconditional international CAPM cannot explain the cross-sectional variation in these portfolio returns. Interestingly, a conditional international asset pricing model that includes foreign exchange risk factors is able to explain a large part of the variation in average returns. Our empirical work suggests that this model has the same explanatory ability as an international three-factor model, where zero-cost portfolios based on earnings-price ratios and market values are used in addition to the world market portfolio. Importantly, the loadings associated with the zero-cost portfolios are driven out by the characteristics themselves, indicating a misspecification.
Keywords: Characteristics, Conditional Information, Foreign Exchange Risk, HML, SMB, World CAPM
JEL Classification: F31, G12, G15
Suggested Citation: Suggested Citation