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Business Cycle Variation in the Risk-Return Trade-Off

35 Pages Posted: 2 Sep 2010 Last revised: 13 Nov 2012

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Adrien Verdelhan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: February 10, 2011

Abstract

In the United States and other Organisation for Economic Co-operation and Development (OECD) countries, the expected returns on stocks, adjusted for volatility, are much higher in recessions than in expansions. We consider feasible trading strategies that buy or sell shortly after business cycle turning points that are identifiable in real time and involve holding periods of up to one year. The observed business cycle changes in expected returns are not spuriously driven by changes in expected near-term dividend growth. Our findings imply that value-maximizing managers face much higher risk-adjusted costs of capital in their investment decisions during recessions than expansions.

Keywords: Risk Premia, Sharpe Ratio

JEL Classification: E44, G12

Suggested Citation

Lustig, Hanno N. and Verdelhan, Adrien, Business Cycle Variation in the Risk-Return Trade-Off (February 10, 2011). Journal of Monetary Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1670715 or http://dx.doi.org/10.2139/ssrn.1670715

Hanno N. Lustig

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Adrien Verdelhan (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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