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Equity market volatility and expected risk premium

  • Long Chen
  • Hui Guo
  • Lu Zhang

This paper revisits the time-series relation between the conditional risk premium and variance of the equity market portfolio. The main innovation is that we construct a measure of the ex ante equity market risk premium using corporate bond yield spread data. This measure is forward-looking and does not rely critically on either realized equity returns or instrumental variables. We find strong support for a positive risk-return tradeoff, and this result is not sensitive to a number of robustness checks, including alternative proxies of the conditional stock variance and controls for hedging demands.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2006-007.

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Date of creation: 2006
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Handle: RePEc:fip:fedlwp:2006-007
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