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Regime Switches in the Risk-Return Trade-off

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  • Ghysels, Eric
  • Guérin, Pierre
  • Marcellino, Massimiliano

Abstract

This paper deals with the estimation of the risk-return trade-off. We use a MIDAS model for the conditional variance and allow for possible switches in the risk-return relation through a Markov-switching specification. We find strong evidence for regime changes in the risk-return relation. This finding is robust to a large range of specifications. In the first regime characterized by low ex-post returns and high volatility, the risk-return relation is reversed, whereas the intuitive positive risk-return trade-off holds in the second regime. The first regime is interpreted as a "flight-to-quality" regime.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9698.

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Date of creation: Oct 2013
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Handle: RePEc:cpr:ceprdp:9698

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Keywords: conditional variance; Markov-switching; MIDAS; Risk-return trade-off;

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