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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27217
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| Title: | Uncovering the Risk-Return Relation in the Stock Market |
| Authors: | Guo, Hui
Whitelaw, Robert F. |
| Issue Date: | 21-Jul-2003 |
| Series/Report no.: | FIN-03-021 |
| Abstract: | There is an ongoing debate in the literature about the apparent weak or
negative relation between risk (conditional variance)and return
(expected returns)in the aggregate stock market. We develop and estimate
an empirical model based on the ICAPM to investigate this relation.Our
primary innovation is to model and identify empirically the two
components of expected returns –the risk component and the
component due to the desire to hedge changes in investment
opportunities. We also explicitly model the e .ect of shocks to expected
returns on ex post returns and use implied volatility from aded options
to increase estimation e .ciency.As a result,the coe .cient of relative
risk aversion is estimated more precisely,and we .nd it to be positive
and reasonable in magnitude. Although volatility risk is priced,as
theory dictates,it conibutes only a small amount to the time-variation
in expected returns.Expected returns are driven primarily by the desire
to hedge changes in investment opportunities.It is the omission of this
hedge component that is responsible for the conadictory and
counter-intuitive results in the existing literature. |
| URI: | http://hdl.handle.net/2451/27217 |
| Appears in Collections: | Finance Working Papers
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