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There is a Risk-Return Tradeoff After All

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Author Info
Eric Ghysels
Pedro Santa-Clara
Rossen Valkanov

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Abstract

This paper studies the ICAPM intertemporal relation between the conditional mean and the 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 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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10913.

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Date of creation: Nov 2004
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Handle: RePEc:nbr:nberwo:10913

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G1 - Financial Economics - - General Financial Markets

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