The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects

Joachim Henkel ()

No 6538, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The concept of risk is central to strategy research and practice. Yet, the expected positive association between risk and return, familiar from financial markets, is elusive. Measuring risk as the variance of a series of accounting-based returns, Bowman obtained the puzzling result of a negative association between risk and mean return. This finding, known as the Bowman paradox, has spawned a remarkable number of publications, and various explanations have been suggested. The present paper contributes to this literature by showing that skewness of individual firms? return distributions has a considerable spurious effect on the mean-variance relationship. I devise a method to disentangle true and spurious effects, illustrate it using simulations, and apply it to empirical data. It turns out that the size of the spurious effect is such that, on average, it explains the larger part of the observed negative relationship. My results might thus help to reconcile mean-variance approaches to risk-return analysis with other, ex-ante, approaches. In concluding, I show that the analysis of skewness is linked to all three streams of literature devoted to explaining the Bowman paradox.

Keywords: Mean-variance; Risk; Risk-return paradox; Skewness (search for similar items in EconPapers)
JEL-codes: C81 G39 M29 (search for similar items in EconPapers)
Date: 2007-10
New Economics Papers: this item is included in nep-bec and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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