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Time‐Varying Risk–Return Trade‐off in the Stock Market

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  • HUI GUO
  • ZIJUN WANG
  • JIAN YANG

Abstract

We uncover a strong comovement of the stock market risk–return trade‐off with the consumption–wealth ratio (CAY). The finding reflects time‐varying investment opportunities rather than countercyclical aggregate relative risk aversion. Specifically, the partial risk–return trade‐off is positive and constant when we control for CAY as a proxy for investment opportunities. Moreover, conditional market variance scaled by CAY is negatively priced in the cross‐section of stock returns. Our results are consistent with a limited stock market participation model, in which shareholders require an illiquidity premium that increases with CAY, in addition to the risk premium that is proportional to conditional market variance.

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  • Hui Guo & Zijun Wang & Jian Yang, 2013. "Time‐Varying Risk–Return Trade‐off in the Stock Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(4), pages 623-650, June.
    • Handle: RePEc:wly:jmoncb:v:45:y:2013:i:4:p:623-650
    DOI: 10.1111/jmcb.12018
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