The Risk-Return Tradeoff: Evidence from a Broad Sample of Developed Markets
87 Pages Posted: 19 Aug 2022 Last revised: 16 Nov 2023
Date Written: August 13, 2022
A positive relation between risk and return is a fundamental tenet of finance. Despite the theoretical prediction of a positive time-series relation between risk and return at the market level, empirical evidence is mixed, with studies finding evidence of positive, negative, or insignificant relations. Due to low test power, using small samples can result in negative or insignificant coefficient estimates on the conditional variance—even when the true relation is positive. I pool data across 33 developed countries, covering almost 2,600 years of market returns, which provides the most comprehensive test to date of the time-series relation of risk and return. Using the full sample of developed country returns, I confirm the fundamental prediction about risk and return: the estimated mean-variance coefficient is positive with strong statistical significance. The regressions with individual country returns yield insignificant results with few exceptions, highlighting the need for an expanded sample.
Keywords: Risk-return tradeoff, ICAPM, test power
JEL Classification: C22, C58, G10, G12, G15, N20
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