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Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital

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  • Lubos Pastor
  • Meenakshi Sinha
  • Bhaskaran Swaminathan

Abstract

We reexamine the time-series relation between the conditional mean and variance of stock market returns. To proxy for the conditional mean return, we use the implied cost of capital, computed using analyst forecasts. The usefulness of this proxy is shown in simulations. In empirical analysis, we construct the time series of the implied cost of capital for the G-7 countries. We find strong support for a positive intertemporal mean-variance relation at both the country level and the world market level. Some of our evidence is consistent with international integration of the G-7 financial markets.

Suggested Citation

  • Lubos Pastor & Meenakshi Sinha & Bhaskaran Swaminathan, 2006. "Estimating the Intertemporal Risk-Return Tradeoff Using the Implied Cost of Capital," NBER Working Papers 11941, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:11941
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    • G1 - Financial Economics - - General Financial Markets

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