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Expectations of Equity Risk Premia, Volatility and Asymmetry from a Corporate Finance Perspective

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  • John R. Graham
  • Campbell R. Harvey

Abstract

We present new evidence on the distribution of the ex ante risk premium based on a multi-year survey of Chief Financial Officers (CFOs) of U.S. corporations. Currently, we have responses from surveys conducted from the second quarter of 2000 through the third quarter of 2001. The results in this paper will be augmented as future surveys become available. We find direct evidence that the one-year risk premium is highly variable through time and 10-year expected risk premium is stable. In particular, after periods of negative returns, CFOs significantly reduce their one-year market forecasts, disagreement (volatility) increases and returns distributions are more skewed to the left. We also examine the relation between ex ante returns and ex ante volatility. The relation between the one-year expected risk premium and expected risk is negative. However, our research points to the importance of horizon. We find a significantly positive relation between expected return and expected risk at the 10-year horizon.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8678.

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Date of creation: Dec 2001
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Handle: RePEc:nbr:nberwo:8678

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  1. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-66.
  2. John Y. Campbell & Ludger Hentschel, 1991. "No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns," NBER Working Papers 3742, National Bureau of Economic Research, Inc.
  3. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
  4. Campbell, John, 1987. "Stock Returns and the Term Structure," Scholarly Articles 3207699, Harvard University Department of Economics.
  5. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
  6. Giordani, Paolo & Soderlind, Paul, 2003. "Inflation forecast uncertainty," European Economic Review, Elsevier, vol. 47(6), pages 1037-1059, December.
  7. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  8. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. " On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December.
  9. Ivo Welch, 2001. "The Equity Premium Consensus Forecast Revisited," Cowles Foundation Discussion Papers 1325, Cowles Foundation for Research in Economics, Yale University.
  10. Ravi Jagannathan & Iwan Meier, 2002. "Do We Need CAPM for Capital Budgeting?," NBER Working Papers 8719, National Bureau of Economic Research, Inc.
  11. Ravi Jagannathan & Ellen R. McGrattan & Anna Scherbina, 2001. "The Declining U.S. Equity Premium," NBER Working Papers 8172, National Bureau of Economic Research, Inc.
  12. Donald L. Keefer & Samuel E. Bodily, 1983. "Three-Point Approximations for Continuous Random Variables," Management Science, INFORMS, vol. 29(5), pages 595-609, May.
  13. Kenneth R. French & James M. Poterba, 1991. "Investor Diversification and International Equity Markets," NBER Working Papers 3609, National Bureau of Economic Research, Inc.
  14. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
  15. Harvey, Campbell R., 2001. "The specification of conditional expectations," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 573-637, December.
  16. Graham, John R. & Harvey, Campbell R., 1996. "Market timing ability and volatility implied in investment newsletters' asset allocation recommendations," Journal of Financial Economics, Elsevier, vol. 42(3), pages 397-421, November.
  17. Breen, William & Glosten, Lawrence R & Jagannathan, Ravi, 1989. " Economic Significance of Predictable Variations in Stock Index Returns," Journal of Finance, American Finance Association, vol. 44(5), pages 1177-89, December.
  18. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  19. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
  20. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
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