Business Cycle Variation in the Risk-Return Trade-Off
Hanno N. Lustig
UCLA - Anderson School of Management; National Bureau of Economic Research (NBER)
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
February 10, 2011
Journal of Monetary Economics, Forthcoming
In the United States and other Organisation for Economic Co-operation and Development (OECD) countries, the expected returns on stocks, adjusted for volatility, are much higher in recessions than in expansions. We consider feasible trading strategies that buy or sell shortly after business cycle turning points that are identifiable in real time and involve holding periods of up to one year. The observed business cycle changes in expected returns are not spuriously driven by changes in expected near-term dividend growth. Our findings imply that value-maximizing managers face much higher risk-adjusted costs of capital in their investment decisions during recessions than expansions.
Number of Pages in PDF File: 35
Keywords: Risk Premia, Sharpe Ratio
JEL Classification: E44, G12
Date posted: September 2, 2010 ; Last revised: November 13, 2012
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