Expected stock returns and volatility

Attention is focused on whether the expected market risk premium, defined as the expected return on a stock market portfolio minus the risk-free interest rate, is positively related to risk as measured by the volatility of the stock market. Daily returns are used to compute estimates of monthly vola...

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Bibliographic Details
Published in:Journal of financial economics 1987-09, Vol.19 (1), p.3-29
Main Authors: Stambaugh, Robert F, Schwert, G. William, French, Kenneth R
Format: Article
Language:English
Subjects:
Common stock
Fluctuations
Mathematical models
Rates of return
Regression analysis
Risk premiums
Securities markets
Stocks
Uncertainty
Volatility
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Summary:Attention is focused on whether the expected market risk premium, defined as the expected return on a stock market portfolio minus the risk-free interest rate, is positively related to risk as measured by the volatility of the stock market. Daily returns are used to compute estimates of monthly volatility, and these estimates are decomposed into predictable and unpredictable components using univariate autoregressive integrated moving average (ARIMA) models. Regressions of monthly excess holding period returns on the predictable component offer little evidence of a positive relation between ex ante volatility and expected risk premiums. However, a strong negative relation is found between excess holding period returns and the unpredictable component of volatility -- providing indirect evidence of a positive ex ante relation. Daily returns also are used to estimate ex ante measures of volatility with a generalized autoregressive conditional heteroskedasticity (GARCH) model. The results support the interpretation of the ARIMA results.
ISSN:0304-405X
1879-2774
DOI:10.1016/0304-405X(87)90026-2