Hostname: page-component-78c5997874-g7gxr Total loading time: 0 Render date: 2024-11-15T08:00:14.617Z Has data issue: false hasContentIssue false
  • English
  • Français

Risk, Uncertainty, and Expected Returns

Published online by Cambridge University Press:  29 July 2016

Turan G. Bali  and
Hao Zhou
Turan G. Bali
Affiliation:
tgb27@georgetown.edu, Georgetown University, McDonough School of Business, Washington, DC20057
Hao Zhou*
Affiliation:
zhouh@pbcsf.tsinghua.edu.cn, Tsinghua University, PBC School of Finance, Beijing100083, PR China.
*
*Corresponding author: zhouh@pbcsf.tsinghua.edu.cn
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

A conditional asset pricing model with risk and uncertainty implies that the time-varying exposures of equity portfolios to the market and uncertainty factors carry positive risk premia. The empirical results from the size, book-to-market, momentum, and industry portfolios indicate that the conditional covariances of equity portfolios with market and uncertainty predict the time-series and cross-sectional variation in stock returns. We find that equity portfolios that are highly correlated with economic uncertainty proxied by the variance risk premium (VRP) carry a significant annualized 8% premium relative to portfolios that are minimally correlated with VRP.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 3 , June 2016 , pp. 707 - 735
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

References

Aielli, G. P. “Dynamic Conditional Correlation: On Properties and Estimation.” Journal of Business and Economic Statistics, 31 (2013), 282–299.CrossRefGoogle Scholar
Allen, L.; Bali, T. G.; and Tang, Y.. “Does Systemic Risk in the Financial Sector Predict Future Economic Downturns?” Review of Financial Studies, 25 (2012), 3000–3036.Google Scholar
Anderson, E. W.; Ghysels, E.; and Juergens, J. L.. “The Impact of Risk and Uncertainty on Expected Returns.” Journal of Financial Economics, 94 (2009), 233–263.CrossRefGoogle Scholar
Andreou, E.; Ghysels, E.; and Kourtellos, A.. “Regression Models with Mixed Sampling Frequencies.” Journal of Econometrics, 158 (2010), 246–261.Google Scholar
Ang, A.; Hodrick, R.; Xing, Y.; and Zhang, X.. “The Cross-Section of Volatility and Expected Returns.” Journal of Finance, 61 (2006), 259–299.Google Scholar
Bakshi, G., and Kapadia, N.. “Delta-Hedged Gains and the Negative Market Volatility Risk Premium.” Review of Financial Studies, 16 (2003), 527–566.CrossRefGoogle Scholar
Bakshi, G., and Madan, D.. “A Theory of Volatility Spread.” Management Science, 52 (2006), 1945–1956.Google Scholar
Bali, T. G. “The Intertemporal Relation between Expected Returns and Risk.” Journal of Financial Economics, 87 (2008), 101–131.CrossRefGoogle Scholar
Bali, T. G., and Engle, R. F.. “The Intertemporal Capital Asset Pricing Model with Dynamic Conditional Correlations.” Journal of Monetary Economics, 57 (2010), 377–390.Google Scholar
Bates, D. S. “Jumps and Stochastic Volatility: Exchange Rate Process Implicit in Deutsche Mark Options.” Review of Financial Studies, 9 (1996), 69–107.CrossRefGoogle Scholar
Bekaert, G., and Engstrom, E.. “Asset Return Dynamics under Bad Environment–Good Environment Fundamentals.” Working Paper, Columbia University and Federal Reserve Board (2010).Google Scholar
Bekaert, G.; Engstrom, E.; and Xing, Y.. “Risk, Uncertainty, and Asset Prices.” Journal of Financial Economics, 91 (2009), 59–82.CrossRefGoogle Scholar
Bekaert, G.; Hoerova, M.; and Duca, M. L.. “Risk, Uncertainty and Monetary Policy.” Journal of Monetary Economics, 60 (2013), 771–788.Google Scholar
Bollerslev, T. “Generalized Autoregressive Conditional Heteroskedasticity.” Journal of Econometrics, 31 (1986), 307–327.Google Scholar
Bollerslev, T.; Engle, R. F.; and Wooldridge, J. M.. “A Capital Asset Pricing Model with Time-Varying Covariances.” Journal of Political Economy, 96 (1988), 116–131.Google Scholar
Bollerslev, T.; Gibson, M.; and Zhou, H.. “Dynamic Estimation of Volatility Risk Premia and Investor Risk Aversion from Option-Implied and Realized Volatilities.” Journal of Econometrics, 160 (2011), 102–118.Google Scholar
Bollerslev, T.; Tauchen, G.; and Zhou, H.. “Expected Stock Returns and Variance Risk Premia.” Review of Financial Studies, 22 (2009), 4463–4492.CrossRefGoogle Scholar
Bollerslev, T., and Todorov, V.. “Tails, Fears and Risk Premia.” Journal of Finance, 66 (2011), 2165–2211.Google Scholar
Britten-Jones, M., and Neuberger, A.. “Option Prices, Implied Price Processes, and Stochastic Volatility.” Journal of Finance, 55 (2000), 839–866.Google Scholar
Buraschi, A.; Trojani, F.; and Vedolin, A.. “When Uncertainty Blows in the Orchard: Comovement and Equilibrium Volatility Risk Premia.” Journal of Finance, 69 (2014), 101–137.Google Scholar
Campbell, J. Y. “Intertemporal Asset Pricing without Consumption Data.” American Economic Review, 83 (1993), 487–515.Google Scholar
Campbell, J. Y. “Understanding Risk and Return.” Journal of Political Economy, 104 (1996), 298–345.CrossRefGoogle Scholar
Campbell, J. Y.; Giglio, S.; Polk, C.; and Turley, R.. “An Intertemporal CAPM with Stochastic Volatility.” Working Paper, Harvard University (2014).Google Scholar
Campbell, J. Y., and Shiller, R. J.. “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies, 1 (1988), 195–228.Google Scholar
Campbell, S. D., and Diebold, F. X.. “Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence.” Journal of Business and Economic Statistics, 27 (2009), 266–278.CrossRefGoogle Scholar
Caporin, M., and McAleer, M.. “Ten Things You Should Know about the Dynamic Conditional Correlation Representation.” Econometrics, 1 (2013), 115–126.Google Scholar
Carhart, M. M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.CrossRefGoogle Scholar
Carr, P., and Wu, L.. “Variance Risk Premiums.” Review of Financial Studies, 22 (2009), 1311–1341.Google Scholar
Chen, Z., and Epstein, L. G.. “Ambiguity, Risk, and Asset Returns in Continuous Time.” Econometrica, 4 (2002), 1403–1445.CrossRefGoogle Scholar
Diether, K.; Malloy, C.; and Scherbina, A.. “Differences of Opinion and the Cross-Section of Stock Returns.” Journal of Finance, 57 (2002), 2113–2141.CrossRefGoogle Scholar
Drechsler, I., and Yaron, A.. “What’s Vol Got to Do with It?” Review of Financial Studies, 24 (2011), 1–45.Google Scholar
Driessen, J.; Maenhout, P. J.; and Vilkov, G.. “The Price of Correlation Risk: Evidence from Equity Options.” Journal of Finance, 64 (2009), 1377–1406.CrossRefGoogle Scholar
Ellsberg, D. “Risk, Ambiguity, and the Savage Axiom.” Quarterly Journal of Economics, 75 (1961), 643–669.Google Scholar
Engle, R. F. “Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models.” Journal of Business and Economic Statistics, 20 (2002), 339–350.Google Scholar
Epstein, L. G. “A Definition of Uncertainty Aversion.” Review of Economic Studies, 66 (1999), 679–708.CrossRefGoogle Scholar
Epstein, L. G., and Wang, T.. “Intertemporal Asset Pricing under Knightian Uncertainty.” Econometrica, 62 (1994), 283–322.Google Scholar
Epstein, L. G., and Zhang, J.. “Subjective Probabilities on Subjectively Unambiguous Events.” Econometrica, 69 (2001), 265–306.Google Scholar
Fama, E. F., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427–465.Google Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.Google Scholar
Fama, E. F., and MacBeth, J.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 71 (1973), 607–636.CrossRefGoogle Scholar
Gabaix, X. “Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance.” Quarterly Journal of Economics, 127 (2012), 645–700.CrossRefGoogle Scholar
Ghysels, E.; Santa-Clara, P.; and Valkanov, R.. “There Is a Risk-Return Trade-Off after All.” Journal of Financial Economics, 76 (2005), 509–548.Google Scholar
Ghysels, E.; Sinko, A.; and Valkanov, R.. “MIDAS Regressions: Further Results and New Directions.” Econometric Review, 26 (2006), 53–90.Google Scholar
Glosten, L. R.; Jagannathan, R.; and Runkle, D. E.. “On the Relation between the Expected Value and the Volatility of the Nominal Excess Returns on Stocks.” Journal of Finance, 48 (1993), 1779–1801.Google Scholar
Goetzmann, W. N.; Watanabe, A.; and Watanabe, M.. “Investor Expectations, Business Conditions, and the Pricing of Beta-Instability Risk.” Working Paper, Yale University (2009).CrossRefGoogle Scholar
Guo, H., and Savickas, R.. “Idiosyncratic Volatility, Stock Market Volatility, and Expected Stock Returns.” Journal of Business and Economic Statistics, 24 (2006), 43–56.CrossRefGoogle Scholar
Guo, H., and Whitelaw, R. F.. “Uncovering the Risk-Return Relation in the Stock Market.” Journal of Finance, 61 (2006), 1433–1463.Google Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 65–91.Google Scholar
Jiang, G., and Tian, Y.. “Model-Free Implied Volatility and Its Information Content.” Review of Financial Studies, 18 (2005), 1305–1342.Google Scholar
Ju, N., and Miao, J.. “Ambiguity, Learning, and Asset Returns.” Econometrica, 80 (2012), 559–591.Google Scholar
Kelly, B. T. “Tail Risk and Asset Prices.” Review of Financial Studies, 27 (2014), 2841–2871.Google Scholar
Klibanoff, P.; Marinacci, M.; and Mukerji, S.. “A Smooth Model of Decision Making under Ambiguity.” Econometrica, 73 (2005), 1849–1892.Google Scholar
Lundblad, C. “The Risk Return Tradeoff in the Long Run: 1836–2003.” Journal of Financial Economics, 85 (2007), 123–150.Google Scholar
Maccheroni, F.; Marinacci, M.; and Rustichini, A.. “Ambiguity Aversion, Robustness, and the Variational Representation of Preferences.” Econometrica, 74 (2006), 1447–1498.CrossRefGoogle Scholar
Merton, R. C. “An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (1973), 867–887.Google Scholar
Newey, W. K., and West, K. D.. “A Simple Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Noureldin, D.; Shephard, N.; and Sheppard, K.. “Multivariate Rotated ARCH Models.” Journal of Econometrics, 179 (2014), 16–30.Google Scholar
Pan, J. “The Jump-Risk Premia Implicit in Options: Evidence from an Integrated Time-Series Study.” Journal of Financial Economics, 63 (2002), 3–50.Google Scholar
Rosenberg, J. V., and Engle, R. F.. “Empirical Pricing Kernels.” Journal of Financial Economics, 64 (2002), 341–372.Google Scholar
Schmeidler, D. “Subjective Probability and Expected Utility without Additivity.” Econometrica, 57 (1989), 571–587.Google Scholar
Todorov, V. “Variance Risk Premium Dynamics: The Role of Jumps.” Review of Financial Studies, 23 (2010), 345–383.CrossRefGoogle Scholar
Zhou, H. “Variance Risk Premia, Asset Predictability Puzzles, and Macroeconomic Uncertainty.” Working Paper, Federal Reserve Board (2009).Google Scholar
Supplementary material: PDF

Bali and Zhou supplementary material

Bali and Zhou supplementary material 1

Download Bali and Zhou supplementary material(PDF)
PDF 380.1 KB