Estimation of an International Capital Asset Pricing Model with Stocks and Government Bonds

The paper investigates whether US, Japanese and European stock and government bond return indices are jointly priced within a conditional multivariate form of the international Capital asset Pricing Model during the period 1993-2001. It also explores the time variation of the price of market risk within this framework, allowing for a structural change in the prices of market and currency risk. The corresponding conditional optimal portfolio weights are compared with the observed market capitalization weights of the assets. The agreement is found to be better for the stock markets than for the bond markets. Finally, out-of-sample performance of the conditional optimal portfolio is measured relative to the market portfolio of stocks and bonds.