Is There a Positive Intertemporal Tradeoff Between Risk and Return After All?

James Morley

No 915, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: This paper develops an extended version of Turner, Startz, and Nelson's (1989) Markov-switching model of stock returns. The model is motivated as an alternative version of Campbell and Hentschel's (1992) volatility feedback model, with news about future dividends subject to a two-state Markov-switching variance. We are able to identify an endogenous volatility feedback effect by assuming that economic agents acquire information about market volatility that is not directly available to econometricians. Using this model, we find strong evidence for a positive tradeoff between volatility and the equity risk premium, especially for post-War stock returns.

Date: 2000-08-01
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