Financial Markets with Trade on Risk and Return

The Review of Financial Studies, Volume 32, Issue 10

Stanford University Graduate School of Business Research Paper No. 3454563

Posted: 25 Sep 2019

See all articles by Kevin Smith

Kevin Smith

Stanford University Graduate School of Business

Date Written: October 1, 2019

Abstract

In this paper, I develop a model in which risk-averse investors possess private information regarding both a stock’s expected payoff and its risk. These investors trade in the stock and a derivative whose payoff is driven by the stock’s risk. In equilibrium, the derivative is used to speculate on the stock’s risk and to hedge against adverse fluctuations in the stock’s risk. I analyze the derivative price and variance risk premium that arise in this equilibrium and their predictive power for stock returns. Finally, I examine the relationship between prices and trading volume in the stock and derivative.

JEL Classification: D82, G11, G12, G14

Suggested Citation

Smith, Kevin, Financial Markets with Trade on Risk and Return (October 1, 2019). The Review of Financial Studies, Volume 32, Issue 10; Stanford University Graduate School of Business Research Paper No. 3454563. Available at SSRN: https://ssrn.com/abstract=3454563

Kevin Smith (Contact Author)

Stanford University Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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