ASSET PRICING, TIME-VARYING RISK PREMIA AND INTEREST-RATE RISK

This paper investigates the role of interest rate risk in explaining s ecurity price changes. We develop and test a two-factor linear beta pr icing model of security returns in which the factors are the excess re turns on the long-term, riskless bond and the equal-weighted equity ma rket index. We find that time-variation in the interest rate and marke t risk premia influence expected security returns. Furthermore, condit ional interest rate volatility affects security returns, particularly during periods of substantial interest rate movements.