On the Stock Market Variance-Return or Price Relations: A Tale Of Two Variances
80 Pages Posted: 26 Mar 2018 Last revised: 8 Feb 2019
Date Written: September 14, 2018
Stock market variance-return or price relations are sometimes negative and sometimes positive. We explain these puzzling findings using a model with two ("bad" and "good") variances. In the model, conditional equity premium depends positively on bad variance and negatively on good variance. Market prices, which correlate negatively with discount rates, decrease with bad variance and increase with good variance. Because market variance is the sum of bad and good variances, its relation to conditional equity premium or market prices can be negative or positive, depending on relative importance of two variances. Our empirical results support model's main implications.
Keywords: Stock Market Variance, Good Variance, Bad Variance, Conditional Equity Premium, Stock Market Return Predicability, and Anomalies
JEL Classification: C6, E2, G1
Suggested Citation: Suggested Citation