Working Paper: NBER ID: w20245
Authors: Esben Hedegaard; Robert J. Hodrick
Abstract: We examine the prediction of Merton's intertemporal CAPM that time varying risk premiums arise from the conditional covariances of returns on assets with the return on the market and other state variables. We find a positive and significant price of risk for the covariance with the market return that is driven by the time series variation in the conditional covariances, and the risk-premium on the market remains positive and significant after controlling for additional state variables. Our method estimates the risk-return tradeoff in the ICAPM using multiple portfolios as test assets.
Keywords: Risk-Return Tradeoff; Conditional Covariances; Intertemporal CAPM
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| conditional covariance of asset's return with market return (C10) | price of risk (G19) |
| time series variation in conditional covariances (C22) | price of risk for covariance with market return (G17) |
| covariance of asset returns with bond yield (G12) | price of risk (G19) |
| covariance of returns with HML portfolio (C10) | price of risk (G19) |
| conditional covariances of returns on portfolios with market return (C10) | conditional expected returns on portfolios (G11) |