Long-run risk-return trade-offs |
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Authors: | Federico M. Bandi,Benoı&circ t Perron |
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Affiliation: | 1. Graduate School of Business, University of Chicago, 5807 South Woodlawn Avenue, Chicago, IL 60637, USA;2. Dépt. de sciences économiques, Université de Montréal, CIREQ and CIRANO, C.P. 6128, Succ. centre-ville, Montréal, Québec, H3C 3J7 Canada |
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Abstract: | Excess market returns are correlated with past market variance. This dependence is statistically mild at short horizons (thereby leading to a hard-to-detect risk-return trade-off, as in the existing literature) but increases with the horizon and is strong in the long run (i.e., between 6 and 10 years). From an econometric standpoint, we find that the long-run predictive power of past market variance is robust to the statistical properties of long-horizon stock-return predictive regressions. From an economic standpoint, we show that, when conditioning on past market variance, conditional versions of the traditional CAPM and consumption-CAPM yield considerably smaller cross-sectional pricing errors than their unconditional counterparts. |
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Keywords: | G12 |
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