There is a Risk-Return Tradeoff after All
New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
University of North Carolina (UNC) at Chapel Hill - Department of Economics; University of North Carolina Kenan-Flagler Business School
Rossen I. Valkanov
University of California, San Diego (UCSD) - Rady School of Management
NBER Working Paper No. w10913
This paper studies the ICAPM intertemporal relation between the conditional mean and the conditional variance of the aggregate stock market return. We introduce a new estimator that forecasts monthly variance with past daily squared returns -- the Mixed Data Sampling (or MIDAS) approach. Using MIDAS, we find that there is a significantly positive relation between risk and return in the stock market. This finding is robust in subsamples, to asymmetric specifications of the variance process, and to controlling for variables associated with the business cycle. We compare the MIDAS results with tests of the ICAPM based on alternative conditional variance specifications and explain the conflicting results in the literature. Finally, we offer new insights about the dynamics of conditional variance.
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Number of Pages in PDF File: 55working papers series
Date posted: December 8, 2004
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