On the Risk Return Relationship

21 Pages Posted: 22 May 2012

See all articles by Jian-Xin Wang

Jian-Xin Wang

University of Technology Sydney; Financial Research Network (FIRN)

Minxian Yang

UNSW Australia Business School, School of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: May 1, 2012

Abstract

While the risk return trade-off theory suggests a positive relationship between the expected return and the conditional volatility, the volatility feedback theory implies a channel that allows the conditional volatility to negatively affect the expected return. We examine the effects of the risk return trade-off and the volatility feedback in a model where both the return and its volatility are influenced by news arrivals. Our empirical analysis shows that the two effects have approximately the same size with opposite signs for the daily excess returns of seven major developed markets. For the same data set, we also find that a linear relationship between the expected return and the conditional standard deviation is preferable to polynomial-type nonlinear specifications.

Keywords: Risk premium, volatility feedback, GARCH-in-mean, Maximum likelihood, Mixture distributions, Time series

JEL Classification: C22, G10

Suggested Citation

Wang, Jian-Xin and Yang, Minxian, On the Risk Return Relationship (May 1, 2012). UNSW Australian School of Business Research Paper No. 2012 ECON 31. Available at SSRN: https://ssrn.com/abstract=2049649 or http://dx.doi.org/10.2139/ssrn.2049649

Jian-Xin Wang

University of Technology Sydney ( email )

UTS Business School
Finance Decipline
Sydney, NSW
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Minxian Yang (Contact Author)

UNSW Australia Business School, School of Economics ( email )

School of Economics
The University of New South Wales
Sydney, NSW NSW 2052
Australia
93853353 (Phone)

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