Regime Switches in the Risk-Return Trade-Off

45 Pages Posted: 28 Oct 2013

See all articles by Eric Ghysels

Eric Ghysels

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

Pierre Guérin

Government of Canada - Bank of Canada

Massimiliano Giuseppe Marcellino

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: October 2013

Abstract

This paper deals with the estimation of the risk-return trade-off. We use a MIDAS model for the conditional variance and allow for possible switches in the risk-return relation through a Markov-switching specification. We find strong evidence for regime changes in the risk-return relation. This finding is robust to a large range of specifications. In the first regime characterized by low ex-post returns and high volatility, the risk-return relation is reversed, whereas the intuitive positive risk-return trade-off holds in the second regime. The first regime is interpreted as a "flight-to-quality" regime.

Keywords: conditional variance, Markov-switching, MIDAS, Risk-return trade-off

JEL Classification: G10, G12

Suggested Citation

Ghysels, Eric and Guérin, Pierre and Marcellino, Massimiliano, Regime Switches in the Risk-Return Trade-Off (October 2013). CEPR Discussion Paper No. DP9698, Available at SSRN: https://ssrn.com/abstract=2346215

Eric Ghysels (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Gardner Hall, CB 3305
Chapel Hill, NC 27599
United States
919-966-5325 (Phone)
919-966-4986 (Fax)

HOME PAGE: http://https://eghysels.web.unc.edu/

Pierre Guérin

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Massimiliano Marcellino

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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