Good Times or Bad Times? Investors' Uncertainty and Stock Returns

Posted: 8 Dec 2009

See all articles by Arzu Ozoguz

Arzu Ozoguz

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School

Multiple version iconThere are 2 versions of this paper

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

Ozoguz, Arzu, Good Times or Bad Times? Investors' Uncertainty and Stock Returns (November 2009). The Review of Financial Studies, Vol. 22, Issue 11, pp. 4377-4422, 2009, Available at SSRN: https://ssrn.com/abstract=1519262 or http://dx.doi.org/hhn097

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

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