Risk, Uncertainty, and Expected Returns

Turan G. Bali and Hao Zhou

Journal of Financial and Quantitative Analysis, 2016, vol. 51, issue 3, 707-735

Abstract: A conditional asset pricing model with risk and uncertainty implies that the time-varying exposures of equity portfolios to the market and uncertainty factors carry positive risk premia. The empirical results from the size, book-to-market, momentum, and industry portfolios indicate that the conditional covariances of equity portfolios with market and uncertainty predict the time-series and cross-sectional variation in stock returns. We find that equity portfolios that are highly correlated with economic uncertainty proxied by the variance risk premium (VRP) carry a significant annualized 8% premium relative to portfolios that are minimally correlated with VRP.

Date: 2016
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