The conditional intertemporal asset pricing model (ICAPM) is studied where the the government bond index serve as the hedge portfolios in addition to the stock market index. The approach allows for time-varying risk-premium, risk-adjusted returns, market and interest rate risk sensitivities, and residual variances. Betas, risk-adjusted returns, and residual variances are allowed to vary with the levels of conditioning information variables: short-term interest rate level, a measure of interest rate volatility, a measure of interest rate term structure, lagged stock market return and a January indicator variable.

       Tests are done using weekly returns on five size and leverage ranked portfolios, and seven industry sector portfolios. The tests are done for the period 1987 to 1994. Results are reported for the whole period and for two subperiods: the latter half of the period and the period after the floating decision of the Finnish markka (September 9, 1992). Results reject the conditional efficiency of the combination of the stock and bond market indexes.