Expected returns and risk in the stock market

Michael Brennan; Alex Taylor

doi:10.1016/j.jempfin.2023.03.002

Expected returns and risk in the stock market

Michael Brennan, Alex Taylor

A&F Accounting & Finance

Research output: Contribution to journal › Article › peer-review

Abstract

We explain time-varying expected returns by time-variation in the covariance of the market return with the pricing kernel. Simple specifications in which the kernel is spanned by a small number of factors reveal substantial levels of predictability with 1-year R2 of 17–18%. The pricing kernel identified by the model is essentially orthogonal to news about expected returns, suggesting that the predictability of market returns is due to the time-varying risk of cash-flow news.

Original language	English
Pages (from-to)	276-300
Journal	Journal of Empirical Finance
Volume	72
Early online date	15 Mar 2023
DOIs	https://doi.org/10.1016/j.jempfin.2023.03.002
Publication status	Published - 1 Jun 2023

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10.1016/j.jempfin.2023.03.002

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AB - We explain time-varying expected returns by time-variation in the covariance of the market return with the pricing kernel. Simple specifications in which the kernel is spanned by a small number of factors reveal substantial levels of predictability with 1-year R2 of 17–18%. The pricing kernel identified by the model is essentially orthogonal to news about expected returns, suggesting that the predictability of market returns is due to the time-varying risk of cash-flow news.

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JO - Journal of Empirical Finance

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Expected returns and risk in the stock market

Abstract

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