Robert F. Whitelaw
ABSTRACT
Recent empirical evidence suggests that expected stock returns are
weakly, or even negatively, related to the volatility of stock returns
at the market level, and that this relation varies substantially over time.
This evidence contradicts the apparently reliable intuition that risk and
return are positively related and that stock market volatility is a good
proxy for risk. This paper investigates the relation between volatility
and expected returns in a general equilibrium, exchange economy. A relatively
simple model, estimated using aggregate consumption data, is able to duplicate
the salient features of the observed expected return/volatility relation.
The key features of the model are the existence of two regimes with different
consumption growth processes and time-varying correlations between stock
returns and the marginal rate of substitution; thus inducing variability
in the short-run relation between expected returns and volatility and a
weakening of the long-run relation. These results highlight the perils
of relying on intuition from static models. They also have important implications
for the empirical modeling of returns.
Subject: Investments/volatility of asset prices, investments/market
efficiency
(Empirical/Theoretical)
Whitelaw: (212) 998-0338 rwhitela@stern.nyu.edu
To request a copy of this paper click here
The Finance Department Working Paper Series has been generously sponsored
by