The Time-Varying Risk Return Tradeoff in the Long-Run

Lundblad(2007,JFE) shows that the risk-return tradeoff is unequivocally positive with a two-century history of equity market data. However, a further examination of the relation with the UK monthly stock returns from 1836 to 2010 produce still weak risk-return relation. I show that the risk-return relation is mostly positive but varies considerably over time based on a new nonlinear ICAPM with multivariate GARCH-M terms with the time-varying risk-return tradeoffs and hedging coefficients. The often observed negative risk-return relation is statistically insignificant with the 95% confidence bounds. The hedging coefficients also vary significantly across time with negative signs. This complex nonlinearity seems to be the main culprit of the weak risk-return relation.