An Intertemporal CAPM with Stochastic Volatility
72 Pages Posted: 15 Mar 2012 Last revised: 15 Sep 2016
Date Written: August 31, 2016
This paper studies the pricing of volatility risk using the first-order conditions of a long-term equity investor who is content to hold the aggregate equity market rather than overweighting value stocks and other equity portfolios that are attractive to short-term investors. We show that a conservative long-term investor will avoid such overweights in order to hedge against two types of deterioration in investment opportunities: declining expected stock returns, and increasing volatility. Empirically, we present novel evidence that low-frequency movements in equity volatility, tied to the default spread, are priced in the cross-section of stock returns.
Keywords: ICAPM, time-varying expected returns, stochastic volatility, value premium
JEL Classification: G12, N22
Suggested Citation: Suggested Citation