Dynamic and Stochastic Instability and the Unbiased Forward Rate Hypothesis: A Variable Mean Response Approach

Lin, Winston T.

Volume 3, Number 3 / September , Pages 147-221

Multinational Finance Journal, 1999, vol. 3, no. 3, pp. 173-221

Winston T. Lin , State University of New York at Buffalo, U.S.A. Corresponding Author

Abstract:
This paper examines how determinants of volatility and stock returns change with financial crisis. The contributions of the paper are twofold. First, using a GARCH-M framework, risk and return are jointly modeled by using macroeconomic variables both in the variance and the mean equations. The conditional variance equation is specified by including macro-economic variables, a relevant information set for emerging economies, that is often overlooked in various GARCH specifications. Second, determinants of risk and return are investigated before during and after a major financial crisis at ISE. We show that, both the determinants of risk and the risk-return relationship change as the economy switches from one regime to the other.

Keywords : currency betas; five special tests; four-step generalized least squares; mean and variance shifts; the unbiasedness hypothesis; variable-mean-response random coefficients models
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