Time-Varying Relative Risk Aversion in Global Asset Markets

The expected risk premia of global stock markets are investigated by extending the intertemporal capital asset pricing model to allow for conditional moments and time-varying relative risk aversion. The derived model is characterized by traditional linear risk factors as well as nonlinear risk factors, and highlights the importance of the joint interaction between local and world shocks on expected risk premia. Using daily data from 1992 to 2018, on 18 countries across four regions, the empirical results show evidence of time-varying and higher relative risk aversion amongst most advanced stocks markets, than emerging markets which tend to exhibit lower and constant relative risk aversion. In the case of the US expected risk premium, world shocks tend to have their greatest impact when local shocks are large and negative. Model simulations reveal that portfolio diversi cation bene ts can be overstated by nearly 50% by incorrectly assuming constant relative risk aversion