What is the Expected Return on a Stock?

Ian Martin and Christian Wagner

No 11608, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We derive a formula that expresses the expected return on a stock in terms of the risk-neutral variance of the market and the stock's excess risk-neutral variance relative to the average stock. These components can be computed from index and stock option prices; the formula has no free parameters. We test the theory in-sample by running panel regressions of stock returns onto risk-neutral variances. The formula performs well at 6-month and 1-year forecasting horizons, and our predictors drive out beta, size, book-to-market, and momentum. Out-of-sample, we find that the formula outperforms a range of competitors in forecasting individual stock returns. Our results suggest that there is considerably more variation in expected returns, both over time and across stocks, than has previously been acknowledged.

Keywords: Expected returns; Forecast; Risk premia; Implied volatility; Risk-neutral variance (search for similar items in EconPapers)
JEL-codes: E22 E44 G10 G12 G17 G31 G32 (search for similar items in EconPapers)
Date: 2016-11
New Economics Papers: this item is included in nep-fmk, nep-for and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (25)

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Related works:
Journal Article: What Is the Expected Return on a Stock? (2019)
Working Paper: What is the expected return on a stock? (2019)
Working Paper: What Is the Expected Return on a Stock? (2017)
Working Paper: What is the expected return on a stock? (2016)
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