Equity Market Volatility and Expected Risk Premium

Federal Reserve Bank St. Louis Working Paper No. 2006-007

40 Pages Posted: 31 Jan 2006

See all articles by Long Chen

Long Chen

Cheung Kong Graduate School of Business; Luohan Academy

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Lu Zhang

Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)

Date Written: January 2006

Abstract

This paper revisits the time-series relation between the conditional risk premium and variance of the equity market portfolio. The main innovation is that we construct a measure of the ex ante equity market risk premium using corporate bond yield spread data. This measure is forward-looking and does not rely critically on either realized equity returns or instrumental variables. We find strong support for a positive risk-return tradeoff, and this result is not sensitive to a number of robustness checks, including alternative proxies of the conditional stock variance and controls for hedging demands.

Keywords: Expected return, equity market volatility, systematic risk, yield spreads

JEL Classification: G12, E44

Suggested Citation

Chen, Long and Chen, Long and Guo, Hui and Zhang, Lu, Equity Market Volatility and Expected Risk Premium (January 2006). Federal Reserve Bank St. Louis Working Paper No. 2006-007, Available at SSRN: https://ssrn.com/abstract=878687 or http://dx.doi.org/10.2139/ssrn.878687

Long Chen (Contact Author)

Cheung Kong Graduate School of Business ( email )

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Hui Guo

University of Cincinnati - Department of Finance - Real Estate ( email )

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Lu Zhang

Ohio State University - Fisher College of Business ( email )

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National Bureau of Economic Research (NBER)

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