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Rev Fin 1999; 12:631-642
© 1999 the Society for Financial Studies

Article

Time-varying risk and return in the bond market: a test of a new equilibrium pricing model

CJ Campbell, HB Kazemi and P Nanisetty
Iowa State University, USA
University of Massachusetts, Amherst, MA, USA
Prudential Securities, New York, NY, USA
Correspondence to: CJ Campbell, Department of Finance, College of Business, Iowa State University, Ames, IA 50011, USA
e-mail: campcj@iastate.edu

Abstract

This article uses bond market data to empirically test the asset pricing model of Kazemi (1992). According to this model the rate of return on a long-term, pure-discount, default-free bond will be perfectly correlated with changes in the marginal utility of the representative investor. The covariability between financial asset returns and returns on such a bond can therefore serve as a measure of the riskiness of assets. The aim of this study is to determine whether the model can explain cross-sectional differences in the monthly returns of bonds with different maturity dates. We estimate and test the restrictions imposed by the model on returns of default-free bonds, while allowing the conditional distribution of bond returns to be time varying. The model is rejected during the full sample period (1973-1995) and the subperiod (1973-1980) when the Federal Reserve's focus is on interest rates, while the model is not rejected during the subperiod (1981-1995) when the Federal Reserve's focus is on money supply.


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