The International CAPM When Expected Returns are Time Varying

This paper derives a dynamic version of Adler and Dumas' (1983) international CAPM when expected returns are time-varying. In addition to the international CAPM factors, intertemporal hedging of future stock returns and future real exchange-rate changes are also priced factors. The model nests several different CAPMs as special cases. The model is estimated using the data on the equity and foreign exchange returns for the United States, Japan, Germany and the United Kingdom. The restrictions of the nested models are tested. While real exchange risk and intertemporal hedging of future stock return play some role, stock market risk remains the most important factor affecting the excess returns