The Term Structure of the Risk-Return Tradeoff

55 Pages Posted: 14 Jun 2005

See all articles by John Y. Campbell

John Y. Campbell

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Luis M. Viceira

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2005

Abstract

Recent research in empirical finance has documented that expected excess returns on bonds and stocks, real interest rates, and risk shift over time in predictable ways. Furthermore, these shifts tend to persist over long periods of time. In this paper, we propose an empirical model that is able to capture these complex dynamics, yet is simple to apply in practice, and we explore its implications for asset allocation. Changes in investment opportunities can alter the risk-return tradeoff of bonds, stocks, and cash across investment horizons, thus creating a 'term structure of the risk-return tradeoff'. We show how to extract this term structure from our parsimonious model of return dynamics, and illustrate our approach using data from the US stock and bond markets. We find that asset return predictability has important effects on the variance and correlation structure of returns on stocks, bonds and T-bills across investment horizons.

Keywords: Risk-return tradeoff, mean-variance analysis, long-horizon investing, vector autoregression

JEL Classification: G12

Suggested Citation

Campbell, John Y. and Viceira, Luis M., The Term Structure of the Risk-Return Tradeoff (February 2005). CEPR Discussion Paper No. 4914. Available at SSRN: https://ssrn.com/abstract=743125

John Y. Campbell

Harvard University - Department of Economics ( email )

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HOME PAGE: http://scholar.harvard.edu/campbell

National Bureau of Economic Research (NBER)

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Luis M. Viceira (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6331 (Phone)
617-496-6592 (Fax)

HOME PAGE: http://www.people.hbs.edu/lviceira

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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