Risk, Uncertainty, and Expected Returns

Abstract:     
A conditional asset pricing model with risk and uncertainty implies that the time-varying exposures of equity portfolios to the market and uncertainty factors carrypositive risk premiums. The empirical results from the size, book-to-market, and industry portfolios as well as individual stocks indicate that the conditional covariances of equity portfolios (individual stocks) with market and uncertainty predict the time-series and cross-sectional variation in stock returns. We find that equity portfolios that are highly correlated with economic uncertainty proxied by the variance risk premium (VRP) carry a significant, annualized 6 to 8 percent premium relative to portfolios that are minimally correlated with VRP.

Number of Pages in PDF File: 77

Keywords: Risk, Uncertainty, Expected Returns, ICAPM, Time-Series and Cross-Sectional Stock Returns, Variance Risk Premium, Conditional Asset Pricing Model.

JEL Classification: G10, G11, C13

working papers series