Non-Linear Dependence and Stock Return Expectations

We test the asset-pricing impact of non-linear dependence. In an experimental setting, we show that investors consider non-linear dependence in their portfolio selection decisions. Extending these laboratory results, we corroborate this relationship in the cross-section of U.S. stock returns. Importantly, this result remains even after controlling for the exposure to implied correlation. Overall, these findings are consistent with an increased demand for assets that provided hedging benefits during market downturns, suggesting that investors place a premium on non-linear dependence.

Keywords: correlation, return predictability, risk premia, comonotonicity, non-linearity, behavioral economics

JEL Classification: G11, G12, G13, G14, G15, C91

Suggested Citation: Suggested Citation

Inghelbrecht, Koen and Verdickt, Gertjan and Linders, Daniël and Xie, Yong, Non-Linear Dependence and Stock Return Expectations (August 27, 2024). Available at SSRN: https://ssrn.com/abstract=4235236 or http://dx.doi.org/10.2139/ssrn.4235236