The Non-Linear Trade-Off Between Return and Risk and Its Determinants

45 Pages Posted: 23 Oct 2014 Last revised: 23 Mar 2022

See all articles by John Cotter

John Cotter

University College Dublin; University of California, Los Angeles (UCLA) - Anderson School of Management

Enrique Salvador

Universitat Jaume I - Department of Finance and Accounting

Date Written: March 1, 2022

Abstract

We estimate a discrete approximation of the risk-return trade-off for the US market by using the whole universe of stocks from July 1963 to September 2017. We find the relationship between return and total risk to be time-varying and also dependent on the level of risk considered. The proposed positive trade-off is mainly observed during low volatility periods and when we move from low risk up to medium-high risk investments. However, the direction of the trade-off is inverted for the highest risk alternatives especially during high volatility periods. The temporal variation of the risk-return trade-off can be explained by a series of sentiment, macro, credit risk, liquidity and corporate variables. All these determinants suggest that the positive relationship between return and risk is more evident during periods where economic, financial and market conditions improve.

Keywords: time-varying risk-return trade-off, non-linear dependence, cyclical variation, panel regressions, asset pricing

JEL Classification: G10, G12, G15

Suggested Citation

Cotter, John and Salvador, Enrique, The Non-Linear Trade-Off Between Return and Risk and Its Determinants (March 1, 2022). Michael J. Brennan Irish Finance Working Paper Series Research Paper No. 21-3, Available at SSRN: https://ssrn.com/abstract=2513282 or http://dx.doi.org/10.2139/ssrn.2513282

John Cotter

University College Dublin ( email )

School of Business, Carysfort Avenue
Blackrock, Co. Dublin
Ireland
353 1 716 8900 (Phone)
353 1 283 5482 (Fax)

HOME PAGE: http://https://johncotter.org/

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Enrique Salvador (Contact Author)

Universitat Jaume I - Department of Finance and Accounting ( email )

Castellon
E-12071 Castello de la Plana, Castellón de la Plana 12071
Spain

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