Working Paper: NBER ID: w11941
Authors: Lubos Pastor; Meenakshi Sinha; Bhaskaran Swaminathan
Abstract: We reexamine 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: risk-return tradeoff; implied cost of capital; G7 countries
JEL Codes: G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| implied cost of capital (G31) | conditional mean (C29) |
| implied cost of capital (G31) | conditional variance (C29) |
| conditional mean (C29) | conditional variance (C29) |
| implied risk premium (G19) | market volatility (G17) |
| shocks to implied risk premia (G19) | shocks to volatility (C58) |
| conditional mean (C29) | realized returns (G19) |