Equity Market Volatility and Expected Risk Premium
Federal Reserve Bank St. Louis Working Paper No. 2006-007
40 Pages Posted: 31 Jan 2006
Date Written: January 2006
This paper revisits the time-series relation between the conditional risk premium and variance of the equity market portfolio. The main innovation is that we construct a measure of the ex ante equity market risk premium using corporate bond yield spread data. This measure is forward-looking and does not rely critically on either realized equity returns or instrumental variables. We find strong support for a positive risk-return tradeoff, and this result is not sensitive to a number of robustness checks, including alternative proxies of the conditional stock variance and controls for hedging demands.
Keywords: Expected return, equity market volatility, systematic risk, yield spreads
JEL Classification: G12, E44
Suggested Citation: Suggested Citation