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Riskiness Measures and Expected Returns

51 Pages Posted: 11 Apr 2011 Last revised: 27 Feb 2012

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

Nusret Cakici

Fordham University

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management

Date Written: February 17, 2011

Abstract

Inspired by Aumann and Serrano (2008) and Foster and Hart (2009), we propose risk-neutral options’ implied measures of riskiness and investigate their significance in predicting the cross section of expected returns per unit of risk. The empirical analyses indicate a negative and significant link between the forward looking options’ implied measures of riskiness and future stock returns. Stocks in the lowest riskiness portfolio have economically and statistically higher risk-adjusted returns than those in the highest riskiness portfolio. These results are robust to controls for market beta, size, book-to-market, momentum, short-term reversal, and liquidity of individual stocks. Controlling for the risk-neutral measure of skewness and the widely used measures of volatility and downside risk (value-at-risk and expected shortfall) does not affect the significant predictive power of riskiness. The paper also introduces alternative measures of riskiness for the aggregate stock market and shows that aggregate riskiness successfully predicts future economic downturns.

Keywords: Riskiness, economic index of riskiness, operational measure of riskiness, risk-neutral measures, stock returns

JEL Classification: G11, G12, G14, G33

Suggested Citation

Bali, Turan G. and Cakici, Nusret and Chabi-Yo, Fousseni, Riskiness Measures and Expected Returns (February 17, 2011). Available at SSRN: https://ssrn.com/abstract=1806349 or http://dx.doi.org/10.2139/ssrn.1806349

Turan Bali (Contact Author)

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: http://msbonline.georgetown.edu/faculty-research/msf-faculty/turan-bali

Nusret Cakici

Fordham University ( email )

Fordham University
Graduate School of Business
New York, NY 10023
United States
2126366776 (Phone)

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

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