The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects
AbstractThe concept of risk is central to strategy research and practice. Yet, the expected positive association between risk and return, familiar from financial markets, is elusive. Measuring risk as the variance of a series of accounting-based returns, Bowman obtained the puzzling result of a negative association between risk and mean return. This finding, known as the Bowman paradox, has spawned a remarkable number of publications, and various explanations have been suggested. The present paper contributes to this literature by showing that skewness of individual firms’ return distributions has a considerable spurious effect on the mean-variance relationship. I devise a method to disentangle true and spurious effects, illustrate it using simulations, and apply it to empirical data. It turns out that the size of the spurious effect is such that, on average, it explains the larger part of the observed negative relationship. My results might thus help to reconcile mean-variance approaches to risk-return analysis with other, ex-ante, approaches. In concluding, I show that the analysis of skewness is linked to all three streams of literature devoted to explaining the Bowman paradox.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6538.
Date of creation: Oct 2007
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- C81 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Methodology for Collecting, Estimating, and Organizing Microeconomic Data
- G39 - Financial Economics - - Corporate Finance and Governance - - - Other
- M29 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics - - - Other
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-10-27 (All new papers)
- NEP-BEC-2007-10-27 (Business Economics)
- NEP-FMK-2007-10-27 (Financial Markets)
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