TY - JOUR
T1 - A new approach to risk-return trade-off dynamics via decomposition
AU - Frazier, David Tyler
AU - Liu, Xiaochun Martin
PY - 2016
Y1 - 2016
N2 - This paper revisits the puzzling time series relation between risk premium and conditional volatility by proposing a flexible risk-return trade-off that allows for a variety of possible shapes and incorporates potential nonlinearities inherent in excess return dynamics. We derive this flexible risk-return relation using the decomposition approach of Anatolyev and Gospodinov (2010), which splits excess returns into the product of absolute returns and signs. Using this decomposition strategy, we study four major international financial markets. The empirical results support a significant and positive risk-return trade-off that is driven by conditional volatility, market timing and the interdependence between the two components, which is generically related to return skewness.
AB - This paper revisits the puzzling time series relation between risk premium and conditional volatility by proposing a flexible risk-return trade-off that allows for a variety of possible shapes and incorporates potential nonlinearities inherent in excess return dynamics. We derive this flexible risk-return relation using the decomposition approach of Anatolyev and Gospodinov (2010), which splits excess returns into the product of absolute returns and signs. Using this decomposition strategy, we study four major international financial markets. The empirical results support a significant and positive risk-return trade-off that is driven by conditional volatility, market timing and the interdependence between the two components, which is generically related to return skewness.
U2 - 10.1016/j.jedc.2015.11.002
DO - 10.1016/j.jedc.2015.11.002
M3 - Article
SN - 0165-1889
VL - 62
SP - 43
EP - 55
JO - Journal of Economic Dynamics and Control
JF - Journal of Economic Dynamics and Control
ER -