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The intertemporal risk-Return relation, investor behavior, and technical trading profits: evidence from the G-7 countries

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  • Moonsoo Kang
  • Joshua Krausz
  • Kiseok Nam

Abstract

The intertemporal risk-return relation and investor behavior are both important pricing factors that jointly determine the expected market risk premium. Using the price adjustment process as a control variable, we find that the intertemporal risk-return relation is positive conditional on bad market news, but is non-positive conditional on good market news. This implies that good (bad) market news weakens (strengthens) the positive risk-return relation. The pattern in the distortion of the risk-return relation is consistent with short-term mispricing in which investors overvalue (undervalue) the stock market in reaction to good (bad) market news. We also show that ignoring the price adjustment process in the estimation of the risk-return relation leads to model misspecification and induces an upward (downward) bias in estimates of the relative risk aversion parameter conditional on good (bad) news. Our model of the asymmetric risk-return relation along with the price adjustment process is capable of generating the return dynamics that is attributable to technical trading profits. We suggest that the profitability of technical trading rules is not a violation of market efficiency, but a consequence of trading rules exploiting the asymmetric effect of price changes on the risk-return relation, along with the persistence property of price changes.

Suggested Citation

  • Moonsoo Kang & Joshua Krausz & Kiseok Nam, 2019. "The intertemporal risk-Return relation, investor behavior, and technical trading profits: evidence from the G-7 countries," The European Journal of Finance, Taylor & Francis Journals, vol. 25(8), pages 780-798, May.
    • Handle: RePEc:taf:eurjfi:v:25:y:2019:i:8:p:780-798
    DOI: 10.1080/1351847X.2018.1537980
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    Cited by:

    1. Osman Kilic & Joseph M. Marks & Kiseok Nam, 2022. "Predictable asset price dynamics, risk-return tradeoff, and investor behavior," Review of Quantitative Finance and Accounting, Springer, vol. 59(2), pages 749-791, August.
    2. Chelikani, Surya & Marks, Joseph M. & Nam, Kiseok, 2024. "State-dependent intertemporal risk-return tradeoff: Further evidence," Journal of Economics and Business, Elsevier, vol. 130(C).

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