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Long-run risk-return trade-offs

  • Bandi, Federico M.
  • Perron, Benoît

Excess market returns are correlated with past market variance. This dependence is statistically mild at short horizons (thereby leading to a hard-to-detect risk-return trade-off, as in the existing literature) but increases with the horizon and is strong in the long run (i.e., between 6 and 10 years). From an econometric standpoint, we find that the long-run predictive power of past market variance is robust to the statistical properties of long-horizon stock-return predictive regressions. From an economic standpoint, we show that, when conditioning on past market variance, conditional versions of the traditional CAPM and consumption-CAPM yield considerably smaller cross-sectional pricing errors than their unconditional counterparts.

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Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 143 (2008)
Issue (Month): 2 (April)
Pages: 349-374

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Handle: RePEc:eee:econom:v:143:y:2008:i:2:p:349-374
Contact details of provider: Web page: http://www.elsevier.com/locate/jeconom

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