Measuring the Risk-Return Tradeoff with Time-Varying Conditional Covariances

58 Pages Posted: 23 Jun 2014

See all articles by Esben Hedegaard

Esben Hedegaard

AQR Capital Management, LLC

Robert J. Hodrick

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: June 2014

Abstract

We examine the prediction of Merton's intertemporal CAPM that time varying risk premiums arise from the conditional covariances of returns on assets with the return on the market and other state variables. We find a positive and significant price of risk for the covariance with the market return that is driven by the time series variation in the conditional covariances, and the risk-premium on the market remains positive and significant after controlling for additional state variables. Our method estimates the risk-return tradeoff in the ICAPM using multiple portfolios as test assets.

Suggested Citation

Hedegaard, Esben and Hodrick, Robert J., Measuring the Risk-Return Tradeoff with Time-Varying Conditional Covariances (June 2014). NBER Working Paper No. w20245. Available at SSRN: https://ssrn.com/abstract=2457720

Esben Hedegaard (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Robert J. Hodrick

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

365 Fifth Avenue, 5th Floor
New York, NY 10016-4309
United States

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