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The non-linear trade-off between return and risk and its determinants

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  • Cotter, John
  • Salvador, Enrique

Abstract

We estimate a discrete approximation of the risk-return trade-off for the US market by using the whole universe of stocks from July 1963 to September 2017. We find the relationship between return and total risk to be time-varying and also dependent on the level of risk considered. The proposed positive trade-off is mainly observed during low volatility periods and when we move from low risk up to medium-high risk investments. However, the direction of the trade-off is inverted for the highest risk alternatives especially during high volatility periods. The temporal variation of the risk-return trade-off can be explained by a series of sentiment, macro, credit risk, liquidity and corporate variables. All these determinants suggest that the positive relationship between return and risk is more evident during periods where economic, financial and market conditions improve.

Suggested Citation

  • Cotter, John & Salvador, Enrique, 2022. "The non-linear trade-off between return and risk and its determinants," Journal of Empirical Finance, Elsevier, vol. 67(C), pages 100-132.
    • Handle: RePEc:eee:empfin:v:67:y:2022:i:c:p:100-132
    DOI: 10.1016/j.jempfin.2022.03.002
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    More about this item

    Keywords

    Time-varying risk-return trade-off; Non-linear dependence; Cyclical variation; Panel regressions; Asset pricing;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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