Working Paper: CEPR ID: DP9698
Authors: Eric Ghysels; Pierre Gurin; Massimiliano Marcellino
Abstract: This paper deals with the estimation of the risk-return trade-off. We use a MIDAS model for the conditional variance and allow for possible switches in the risk-return relation through a Markov-switching specification. We find strong evidence for regime changes in the risk-return relation. This finding is robust to a large range of specifications. In the first regime characterized by low ex-post returns and high volatility, the risk-return relation is reversed, whereas the intuitive positive risk-return trade-off holds in the second regime. The first regime is interpreted as a "flight-to-quality" regime.
Keywords: conditional variance; markov-switching; midas; risk-return tradeoff
JEL Codes: G10; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| volatility (conditional variance) (C58) | expected returns (G17) |
| first regime (high volatility and low returns) (G17) | risk-return relation (G11) |
| second regime (lower volatility and higher returns) (G17) | risk-return relation (G11) |
| expected returns (G17) | probability of being in the first regime (C29) |
| volatility (E32) | probability of being in the first regime (C29) |