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The Price of Risk

  • Craig Ellis

    (School of Finance and Economics, University of Western Sydney)

Registered author(s):

    The relationship between risk and return is fundamental to financial asset pricing. Many commonly used financial asset pricing models require an annualised risk coefficient. Using the fundamental asumption that consecutive price changes are independent, annualised risk can be easily calculated from the asset risk over shorter time intervals. Recent empirical research however suggests that price changes are not independent, but rather exhibit long-term dependence. This paper will focus on the implications for investors of incorrectly measuring annualised risk. The outcomes of the paper will show that traditional measures of annualised risk are inappropriate when price changes do not follow a random walk, and will lead the investor to dramatically mis-estimate their real level of risk.

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    File URL: http://www.finance.uts.edu.au/research/wpapers/wp86.pdf
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    Paper provided by Finance Discipline Group, UTS Business School, University of Technology, Sydney in its series Working Paper Series with number 86.

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    Length: 33 pages
    Date of creation: 01 Aug 1999
    Date of revision:
    Handle: RePEc:uts:wpaper:86
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    Web page: http://www.uts.edu.au/about/uts-business-school/finance

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    1. Marco Corazza & A.G. Malliaris & Carla Nardelli, 1997. "Searching for fractal structure in agricultural futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 17(4), pages 433-473, 06.
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    3. Mandelbrot, Benoit B, 1971. "When Can Price Be Arbitraged Efficiently? A Limit to the Validity of the Random Walk and Martingale Models," The Review of Economics and Statistics, MIT Press, vol. 53(3), pages 225-36, August.
    4. Schwert, G William, 2002. "Tests for Unit Roots: A Monte Carlo Investigation," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 5-17, January.
    5. Muller, Ulrich A. & Dacorogna, Michel M. & Olsen, Richard B. & Pictet, Olivier V. & Schwarz, Matthias & Morgenegg, Claude, 1990. "Statistical study of foreign exchange rates, empirical evidence of a price change scaling law, and intraday analysis," Journal of Banking & Finance, Elsevier, vol. 14(6), pages 1189-1208, December.
    6. Hawawini, Gabriel, 1983. "Why beta shifts as the return interval changes," MPRA Paper 44893, University Library of Munich, Germany.
    7. Cheung, Yin-Wong, 1993. "Long Memory in Foreign-Exchange Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(1), pages 93-101, January.
    8. Drost, F.C. & Nijman, T.E., 1993. "Temporal aggregation of GARCH processes," Other publications TiSEM 0642fb61-c7f4-4281-b484-4, Tilburg University, School of Economics and Management.
    9. van de Gucht, Linda M. & Dekimpe, Marnik G. & Kwok, Chuck C. Y., 1996. "Persistence in foreign exchange rates," Journal of International Money and Finance, Elsevier, vol. 15(2), pages 191-220, April.
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