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There is a Risk-Return Tradeoff After All

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Author Info
Eric Ghysels (University of North Carolina and CIRANO)
Pedro Santa-Clara (Anderson School of Management)
Rossen Valkanov (Anderson School of Management)

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Abstract

This paper studies the ICAPM intertemporal relation between conditional mean and conditional variance of the aggregate stock market return. We introduce a new estimator that forecasts monthly variance with past daily squared returns the Mixed Data Sampling (or MIDAS) approach. Using MIDAS, we find that there is a significantly positive relation between risk and return in the stock market. This finding is robust in subsamples, to asymmetric specifications of the variance process, and to controlling for variables associated with the business cycle. We compare the MIDAS results with other tests of the ICAPM based on alternative conditional variance specifications and explain the conflicting results in the literature. Finally, we offer new insights about the dynamics of conditional variance.

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Paper provided by Anderson Graduate School of Management, UCLA in its series University of California at Los Angeles, Anderson Graduate School of Management with number 1155.

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Date of creation: 01 Apr 2003
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