UK STOCK RETURNS AND ROBUST-TESTS OF MEAN-VARIANCE EFFICIENCY

We test both the unconditional and conditional Mean Variance Efficienc y of the UK stockmarket, paying particular attention to choosing a sui table set of instruments for the conditional version of the model. By considering more carefully than previous authors the pricing of econom ic risk within the mean-variance framework we show that certain instru ments can enhance the basic model structure. Given the tendency for fi nancial market data to display non-constancy in variance and non-norma lity we employ the GMM procedure described in Hansen (1982), which req uires much weaker distributional assumptions than the more traditional OLS techniques. We discuss forming portfolios of stocks using both si ze and dividend yield as a criterion to achieve a suitable spread of r isk and return, acid find that our conclusions are sensitive both to t he method of portfolio formation and to the choice of estimator. This is an important finding given the problem of thin trading associated w ith the size ordering of UK stocks. We find some support for both the unconditional and conditional version of the CAPM, though we are cauti ous about our conclusions given the instability of the parameter estim ates.