Understanding the Risk-Return Tradeoff in the Stock Market

51 Pages Posted: 19 Dec 2001

See all articles by Hui Guo

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Date Written: December 2001

Abstract

We find that past stock market variance forecasts excess stock market returns and that its predictive ability is greatly enhanced if the consumption-wealth ratio is also included in the forecasting equation. While the risk-return tradeoff is found negative if we use the latter as the instrumental variable for the conditional moments, the former suggests a positive one. We argue that the consumption-wealth ratio is closely related to the hedge component of excess returns as in Merton's (1973) intertemporal capital asset pricing model: market risk is indeed positively priced if we control for the hedge component.

Keywords: Risk-Return Tradeoff, Hedge Component of Excess Returns

JEL Classification: G1

Suggested Citation

Guo, Hui, Understanding the Risk-Return Tradeoff in the Stock Market (December 2001). Available at SSRN: https://ssrn.com/abstract=294425 or http://dx.doi.org/10.2139/ssrn.294425

Hui Guo (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business
418 Carl H. Lindner Hall
Cincinnati, OH 45221
United States
513.556.7077 (Phone)
513.556.0979 (Fax)

HOME PAGE: http://homepages.uc.edu/~guohu/

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