Working Paper: CEPR ID: DP5462
Authors: Lubos Pstor; Meenakshi Sinha; Bhaskaran Swaminathan
Abstract: We re-examine the time-series relation between the conditional mean and variance of stock market returns. To proxy for the conditional mean return, we use the implied cost of capital, computed using analyst forecasts. The usefulness of this proxy is shown in simulations. In empirical analysis, we construct the time series of the implied cost of capital for the G-7 countries. We find strong support for a positive intertemporal mean-variance relation at both the country level and the world market level. Some of our evidence is consistent with international integration of the G-7 financial markets.
Keywords: Implied Cost of Capital; International Integration; Risk-Return Tradeoff
JEL Codes: G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| conditional mean (C29) | conditional variance (C29) |
| implied cost of capital (G31) | expected returns (G17) |
| implied cost of capital (G31) | mean-variance relation (C29) |
| realized returns (G19) | mean-variance relation (C29) |
| implied risk premia (D81) | market volatility (G17) |
| shocks to implied risk premia (G19) | shocks to volatility (C58) |