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Can macroeconomic dynamics explain the time variation of risk–return trade-offs in the U.S. financial market?

Xiaochun Liu ()

The Quarterly Review of Economics and Finance, 2017, vol. 66, issue C, 275-293

Abstract: This paper explores potential economic sources that drive risk–return trade-off dynamics both in-sample and out-of-sample. Using the stochastic dominance test, I find statistical evidence that the risk–return trade-off procyclically varies with business cycles and asymmetrically responses to market timing. Moreover, based on a set of commonly used macroeconomic variables, the macroeconomic fluctuations explain about 30.4% on average of risk–return trade-off dynamics, with significantly delayed macroeconomic effect up to 12 months. For the purpose of robustness, the results from macroeconomic predictive regressions are further generalized by the principle component analysis with an expanded number of macroeconomic variables.

Keywords: Flexible partial risk–return relation; Stochastic dominance tests; Return decomposition; Time-varying skewness; Principle components (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2017
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