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Regime Switches in the Risk-Return Trade-Off

Listed author(s):
  • Eric Ghysels
  • Pierre Guérin
  • Massimiliano Marcellino

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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File URL: http://www.bankofcanada.ca/wp-content/uploads/2013/12/wp2013-51.pdf
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Paper provided by Bank of Canada in its series Staff Working Papers with number 13-51.

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Length: 45 pages
Date of creation: 2013
Handle: RePEc:bca:bocawp:13-51
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