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Regime switches in the risk–return trade-off

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  • Ghysels, Eric
  • Guérin, Pierre
  • Marcellino, Massimiliano

Abstract

This paper deals with the estimation of the risk–return trade-off. We use a MIDAS model for the conditional variance and allow for possible switches in the risk–return relation through a Markov-switching specification. We find strong evidence for regime changes in the risk–return relation. This finding is robust to a large range of specifications. In the first regime characterized by low ex-post returns and high volatility, the risk–return relation is reversed, whereas the intuitive positive risk–return trade-off holds in the second regime. The first regime is interpreted as a “flight-to-quality” regime.

Suggested Citation

  • Ghysels, Eric & Guérin, Pierre & Marcellino, Massimiliano, 2014. "Regime switches in the risk–return trade-off," Journal of Empirical Finance, Elsevier, vol. 28(C), pages 118-138.
    • Handle: RePEc:eee:empfin:v:28:y:2014:i:c:p:118-138
    DOI: 10.1016/j.jempfin.2014.06.007
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    More about this item

    Keywords

    Risk–return trade-off; Markov-switching; MIDAS; Conditional variance;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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