Does the market reward risk in non-January months?

Abstract

T his paper examines market rewards for risk . bearing by comparing spreads between month-tomonth holding-period returns on long-term corporate and government bonds, on stocks and government bonds, and on stocks and bonds of the same firm. The spreads we use are for securities whose risk attributes are fundamentally different from one another, so no need exists to calculate beta or other risk estimators. To the extent that stocks are riskier than corporate bonds that, in turn, are riskier than government bonds, the mean holding-period return spreads can be interpreted as risk premiums. If investors are risk-averse, these premiums should be systematically positive. Our findings do not support that prediction. Although the mean spread between corporate and government securities is positive and statistically significant in January, we failed to find a consistent and positive risk-return relationship in the other months of the year. In the case of stocks and bonds of the same firm, even the January spreads show only weak support for a positive risk-return trade-off. Hence, our findings are similar to the findings of Tinic and West (1984). The positive risk-return relationship that much of finance theory posits can be detected on a regular basis only in January, if it is detected at all. Our findings also indicate that the riskreturn trade-off is absent in the bond market as well as in the stock market, and that the result cannot be attributed to deficiencies in testing the CAPM.