The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects

28 Pages Posted: 13 Sep 2007 Last revised: 26 Mar 2013

See all articles by Joachim Henkel

Joachim Henkel

TUM School of Management - Technical University of Munich (TUM)

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Date Written: January 2008

Abstract

The concept of risk is central to strategy research and practice. Yet, the expected positive association between risk and return, familiar from financial markets, is elusive. Measuring risk as the variance of a series of accounting-based returns, Bowman obtained the puzzling result of a negative association between risk and mean return. This finding, known as the Bowman paradox, has spawned a remarkable number of publications, and various explanations have been suggested. The present paper contributes to this literature by showing that skewness of individual firms' return distributions has a considerable spurious effect on the empirically estimated mean-variance relationship. I devise a method to disentangle true and spurious effects, illustrate it using simulations, and apply it to empirical data. It turns out that the size of the spurious effect is such that, on average, it explains the larger part of the observed negative relationship. My results might thus help to reconcile mean-variance approaches to risk-return analysis with other, ex-ante, approaches. In concluding, I show that the analysis of skewness is linked to all three streams of literature devoted to explaining the Bowman paradox.

Keywords: mean-variance, risk, risk-return paradox, skewness

JEL Classification: C81, G39, M29

Suggested Citation

Henkel, Joachim, The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects (January 2008). Available at SSRN: https://ssrn.com/abstract=1014325 or http://dx.doi.org/10.2139/ssrn.1014325

Joachim Henkel (Contact Author)

TUM School of Management - Technical University of Munich (TUM) ( email )

Arcisstr. 21
Munich, D-80333
Germany

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