On the risk return relationship
AbstractWhile the risk return trade-off theory suggests a positive relationship between the expected return and the conditional volatility, the volatility feedback theory implies a channel that allows the conditional volatility to negatively affect the expected return. We examine the effects of the risk return trade-off and the volatility feedback in a model where both the return and its volatility are influenced by news arrivals. Our empirical analysis shows that the two effects have approximately the same size with opposite signs for the daily excess returns of seven major developed markets. For the same data set, we also find that a linear relationship between the expected return and the conditional standard deviation is preferable to polynomial-type nonlinear specifications. Our results have a potential to explain some of the mixed findings documented by previous studies.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Empirical Finance.
Volume (Year): 21 (2013)
Issue (Month): C ()
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Web page: http://www.elsevier.com/locate/jempfin
Risk premium; Volatility feedback; GARCH-in-mean; Maximum likelihood; Mixture distributions; Time series;
Other versions of this item:
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
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