Good Times or Bad Times? Investors' Uncertainty and Stock Returns
Posted: 8 Dec 2009
There are 2 versions of this paper
Good Times or Bad Times? Investors' Uncertainty and Stock Returns
Date Written: November 2009
Abstract
This paper investigates empirically the dynamics of investors' beliefs and Bayesian uncertainty about the state of the economy as state variables that describe the time-variation in investment opportunities. Using measures of uncertainty constructed from the state probabilities estimated from two-state regime-switching models of aggregate market return and of aggregate output, I find a negative relationship between the level of uncertainty and asset valuations. This relationship shows substantial cross-sectional variation across portfolios sorted on size, book-to-market, and past returns, especially conditional on the state of the economy. I show that a conditional model with investors' beliefs and an uncertainty risk factor is remarkably successful in explaining a large part of the cross-sectional variation in average portfolio returns. The uncertainty risk factor retains its incremental explanatory power when compared to other conditional models such as the conditional CAPM.
JEL Classification: G12, G14, D80
Suggested Citation: Suggested Citation
Arzu Ozoguz (Contact Author)
University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School ( email )
McColl Building
Chapel Hill, NC 27599-3490
United States