Time-Varying Risk Premia and the Cross Section of Stock Returns

66 Pages Posted: 13 Aug 2002

See all articles by Hui Guo

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Date Written: July 15, 2002

Abstract

This paper shows that the consumption-wealth ratio, realized stock market variance, and the stochastically detrended risk-free rate are strong predictors of stock market returns as well as returns on portfolios formed according to various sorting criteria. The Capital Asset Pricing Model (CAPM) and the Fama and French (1993) three-factor model fail to explain the dynamic pattern of stock portfolio returns tracked by the lagged forecasting variables. However, we cannot reject Campbell's (1993) Intertemporal CAPM, in which risk factors include a stock market return and variables forecasting stock market returns. We find that (1) the relative risk aversion coefficient is positive and statistically significant; (2) all the risk factors are significantly priced; (3) heteroskedasticity in stock returns has significant effects on asset prices. Also, shareholders tend to be more risk-averse towards value stocks than growth or glamour stocks. Therefore, in addition to stock market risk, a hedge for time-varying investment opportunities and possibly different risk attitudes are important to explain the cross section of stock returns.

Keywords: Stock Return Predictability, Time-varying Investment Opportunities, Asset Pricing, and Cross Section of Stock Returns

JEL Classification: G10, G12

Suggested Citation

Guo, Hui, Time-Varying Risk Premia and the Cross Section of Stock Returns (July 15, 2002). Available at SSRN: https://ssrn.com/abstract=320000 or http://dx.doi.org/10.2139/ssrn.320000

Hui Guo (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business
418 Carl H. Lindner Hall
Cincinnati, OH 45221
United States
513.556.7077 (Phone)
513.556.0979 (Fax)

HOME PAGE: http://homepages.uc.edu/~guohu/

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