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Market Prices of Risk and Return Predictability in a Joint Stock-Bond Pricing Model

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  • Harry Mamaysky

Abstract

This paper examines the related questions, of the time-series behavior of expected returns and of return predictability, within the framework of the stock-bond pricing model proposed in Mamaysky (2002). The key advantage of the model-based approach adopted in this paper is that the quantities of interest (i.e. expected returns, prices of risk, and R2's of forecasting regressions of returns on their true conditional expectations) are directly observable (once the model has been fitted to the data). Furthermore, the fact that the present model accomodates jointly the pricing of both bonds and stocks allows us to derive estimates of prices of risk and of expected returns that incorporate, by construction, the relevant information from both bond and stock markets. Estimation of the model using U.S. data reveals a rich dynamic structure of prices of risk, some pro- and some countercyclical, and of expected returns. Also, the paper suggests that excess return predictability (as measured by the

Suggested Citation

  • Harry Mamaysky, 2002. "Market Prices of Risk and Return Predictability in a Joint Stock-Bond Pricing Model," Yale School of Management Working Papers ysm297, Yale School of Management, revised 01 Oct 2002.
  • Handle: RePEc:ysm:somwrk:ysm297
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    File URL: http://icfpub.som.yale.edu/publications/2505
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    Cited by:

    1. Adrian, Tobias & Crump, Richard K. & Moench, Emanuel, 2015. "Regression-based estimation of dynamic asset pricing models," Journal of Financial Economics, Elsevier, vol. 118(2), pages 211-244.
    2. Bekaert, Geert & Engstrom, Eric & Grenadier, Steven R., 2010. "Stock and bond returns with Moody Investors," Journal of Empirical Finance, Elsevier, vol. 17(5), pages 867-894, December.
    3. Kassimatis, Konstantinos & Spyrou, Spyros & Galariotis, Emilios, 2008. "Short-term patterns in government bond returns following market shocks: International evidence," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 903-924, December.
    4. Adrian, Tobias & Crump, Richard K. & Vogt, Erik, 2015. "Nonlinearity and flight to safety in the risk-return trade-off for stocks and bonds," Staff Reports 723, Federal Reserve Bank of New York, revised 01 Nov 2017.

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