We analyze the relationship between the stance of monetary policy and the implicit risk aversion in European Stock market prices in an international open-economy framework. We use a structural vector autoregression (SVAR) model that incorporates the effect of a factor that reflects the global monetary policy stance. We use shocks in the US Fed monetary policy stance as a proxy of this global factor. Our results indicate mixed evidence depending on whether simultaneity between domestic monetary policy stance and the stock market behavior is taken into full account. When this simultaneity is not allowed we confirm previous evidence found in the literature, extended to the international field: a lax monetary policy, both domestic and global, decreases risk aversion. However, when we take this into account, results indicate that a lax monetary policy increase in the short-run the risk aversion of the domestic representative investor.

We employ MIDAS (mixed data sampling) to study the risk–expected return trade-off in several European stock indices. Using MIDAS, we report that in most indices there is a significant positive relationship between risk and expected return. This strongly contrasts with the result we obtain when we employ both symmetric and asymmetric GARCH models for conditional variance. We also find that asymmetric specifications of the variance process within the MIDAS framework improve the relationship between risk and expected return. As an additional application, we analyze the extent to which European stock markets are integrated, which is a particularly relevant issue, especially following the launch of the Euro in January 1999. Finally, we propose a bivariate MIDAS specification to test the pricing significance of the hedging component within an intertemporal risk–return trade-off with multiple European market indices.