Risk and Return: Some New Evidence
October 2000
Hui Guo and Robert Whitelaw
ABSTRACT
We develop a structural asset pricing model to investigate the relationship between stock market risk and return.
The structural model is estimated using the conditional market variance implied by S&P 100 index option prices.
Relative risk aversion is precisely identified and is found to be positive, with point estimates ranging from 3.06
to 4.01. However, the implied volatility data only spans the period November 1983 to May 1995. As a robustness
check, the structural model is also examined with postwar monthly data, in which the conditional market variance
is estimated. We again find a positive and significant risk-return relation and get similar point estimates for
relative risk aversion. Additionally, we document some facts about stock market return. First, stock price movements
are primarily driven by changes in investment opportunities, not by changes in market volatility. Second, there
is some evidence of a leverage effect. Third, relative risk aversion is quite stable over time.
Subject: Investments, Investments/Predictability of Asset Returns, Investments/Volatility of Asset Prices
Classification: Empirical
Hui Guo
Institution: Federal Reserve Bank of St. Louis
Email: hui.guo@stls.frb.org
Robert Whitelaw
Institution: Stern School of Business, New York University
Email: rwhitela@stern.nyu.edu
Telephone: (212) 998-0338
Home Page: http://www.stern.nyu.edu/~rwhitela/
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