The Term Structure of the Risk-Return Tradeoff

John Campbell and Luis Viceira

No 4914, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Recent research in empirical finance has documented that expected excess returns on bonds and stocks, real interest rates, and risk shift over time in predictable ways. Furthermore, these shifts tend to persist over long periods of time. In this paper we propose an empirical model that is able to capture these complex dynamics, yet is simple to apply in practice, and we explore its implications for asset allocation. Changes in investment opportunities can alter the risk-return tradeoff of bonds, stocks, and cash across investment horizons, thus creating a ?term structure of the risk-return tradeoff?. We show how to extract this term structure from our parsimonious model of return dynamics, and illustrate our approach using data from the US stock and bond markets. We find that asset return predictability has important effects on the variance and correlation structure of returns on stocks, bonds and T-bills across investment horizons.

Keywords: Risk-return tradeoff; Mean-variance analysis; Long-horizon investing; Vector autoregression (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2005-02
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (67)

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Related works:
Journal Article: The Term Structure of the Risk–Return Trade-Off (2005)
Working Paper: The Term Structure of the Risk-Return Tradeoff (2005)
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