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The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects

Joachim Henkel

TUM School of Management - Technische Universität München (TUM); Centre for Economic Policy Research (CEPR)

CEPR Discussion Paper No. DP6538

The concept of risk is central to strategy research and practice. Yet, the expected positive association between risk and return, familiar from financial markets, is elusive. Measuring risk as the variance of a series of accounting-based returns, Bowman obtained the puzzling result of a negative association between risk and mean return. This finding, known as the Bowman paradox, has spawned a remarkable number of publications, and various explanations have been suggested. The present paper contributes to this literature by showing that skewness of individual firms' return distributions has a considerable spurious effect on the mean-variance relationship. I devise a method to disentangle true and spurious effects, illustrate it using simulations, and apply it to empirical data. It turns out that the size of the spurious effect is such that, on average, it explains the larger part of the observed negative relationship. My results might thus help to reconcile mean-variance approaches to risk-return analysis with other, ex-ante, approaches. In concluding, I show that the analysis of skewness is linked to all three streams of literature devoted to explaining the Bowman paradox.

Number of Pages in PDF File: 29

Keywords: mean-variance, risk, risk-return paradox, skewness

JEL Classification: C81, G39, M29

Date posted: June 5, 2008  

Suggested Citation

Henkel, Joachim, The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects. CEPR Discussion Paper No. DP6538. Available at SSRN: http://ssrn.com/abstract=1140065

Contact Information

Joachim Henkel (Contact Author)
TUM School of Management - Technische Universität München (TUM) ( email )
Arcisstr. 21
Munich, D-80333
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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