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Journal of Finance Vol. 61 No. 3 2006

Uncovering the Risk–Return Relation in the Stock Market

Hui Guo1,2; ROBERT F. WHI℡AW3,4

1 University of Cincinnati · 2 Federal Reserve Bank of St. Louis · 3 National Bureau of Economic Research · 4 New York University

open access

Abstract

There is ongoing debate about the apparent weak or negative relation between risk (conditional variance) and expected returns in the aggregate stock market. We develop and estimate an empirical model based on the intertemporal capital asset pricing model (ICAPM) that separately identifies the two components of expected returns, namely, the risk component and the component due to the desire to hedge changes in investment opportunities. The estimated coefficient of relative risk aversion is positive, statistically significant, and reasonable in magnitude. However, expected returns are driven primarily by the hedge component. The omission of this component is partly responsible for the existing contradictory results.

DOI
10.1111/j.1540-6261.2006.00877.x
Volume
61
Issue
3
Pages
1433-1463
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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