Understanding the Risk-Return Relation

The Aggregate Wealth Proxy Actually Matters

Scott H Cederburg, Michael S. O’Doherty

Research output: Contribution to journalArticle

Abstract

The ICAPM implies that the market’s conditional expected return is proportional to its conditional variance and that the reward-to-risk ratio equals the representative investor’s coefficient of relative risk aversion. Prior studies examine this relation using the stock market to proxy for aggregate wealth and find mixed results. We show, however, that stock-based tests suffer from low power and lead to biased estimates of the risk-return tradeoff when stocks are an imperfect market proxy. Tests designed to mitigate this bias by incorporating a more comprehensive measure of aggregate wealth produce large, positive estimates of the risk-aversion coefficient around seven to nine. Supplementary materials for this article are available online.

Original languageEnglish (US)
Pages (from-to)1-15
Number of pages15
JournalJournal of Business and Economic Statistics
DOIs
StateAccepted/In press - May 30 2018

Fingerprint

Risk Aversion
Conditional Variance
Relative Risk
Coefficient
Stock Market
Reward
Imperfect
Estimate
Biased
Trade-offs
Directly proportional
Imply
market
stock market
investor
reward
Market
Coefficients
Wealth
Risk-return

ASJC Scopus subject areas

  • Statistics and Probability
  • Social Sciences (miscellaneous)
  • Economics and Econometrics
  • Statistics, Probability and Uncertainty

Cite this

Understanding the Risk-Return Relation : The Aggregate Wealth Proxy Actually Matters. / Cederburg, Scott H; O’Doherty, Michael S.

In: Journal of Business and Economic Statistics, 30.05.2018, p. 1-15.

Research output: Contribution to journalArticle

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