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
Jacobs Levy Equity Management Center for Quantitative Financial Research Paper
Posted: 25 Sep 2019
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: Suggested Citation
Kevin Smith (Contact Author)
Stanford University Graduate School of Business ( email )
655 Knight Way
Stanford, CA 94305-5015
United States
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