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Business cycle variation in the risk-return trade-off

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  • Lustig, Hanno
  • Verdelhan, Adrien

Abstract

In the United States and other Organisation for Economic Co-operation and Development (OECD) countries, the expected returns on stocks, adjusted for volatility, are much higher in recessions than in expansions. We consider feasible trading strategies that buy or sell shortly after business cycle turning points that are identifiable in real time and involve holding periods of up to 1 year. The observed business cycle changes in expected returns are not spuriously driven by changes in expected near-term dividend growth. Our findings imply that value-maximizing managers face much higher risk-adjusted costs of capital in their investment decisions during recessions than expansions.

Suggested Citation

  • Lustig, Hanno & Verdelhan, Adrien, 2012. "Business cycle variation in the risk-return trade-off," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 35-49.
    • Handle: RePEc:eee:moneco:v:59:y:2012:i:s:p:s35-s49
    DOI: 10.1016/j.jmoneco.2012.11.003
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