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Expected and realized returns in conditional asset pricing models: A new testing approach

Author

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  • Antell, Jan
  • Vaihekoski, Mika

Abstract

We develop a new approach for testing conditional asset pricing models that avoids the issues in using realized returns as a proxy for expected returns. Testable restrictions are developed by asking what realized returns we would observe, given the pricing model under scrutiny. The new reverse testing approach is used to test the Merton ICAPM and a long-standing risk–return puzzle: the price of market risk has often turned out to be insignificant and at times even negative. The results from the new testing approach on US data give strong support for a positive relationship between conditional variance and the equity premium.

Suggested Citation

  • Antell, Jan & Vaihekoski, Mika, 2019. "Expected and realized returns in conditional asset pricing models: A new testing approach," Journal of Empirical Finance, Elsevier, vol. 52(C), pages 220-236.
    • Handle: RePEc:eee:empfin:v:52:y:2019:i:c:p:220-236
    DOI: 10.1016/j.jempfin.2019.04.001
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    More about this item

    Keywords

    Conditional asset pricing; Equity premium; Risk aversion; Risk–return trade-off; Volatility-feedback;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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