Risk–return trade-off in the pacific basin equity markets

Abstract

We conduct an empirical study of risk–return trade-off in fourteen Pacific basin equity markets using several volatility estimators, including five variants of GARCH class, equally weighted rolling window volatility, and mixed data sampling (MIDAS), as well as binormal GARCH (BiN-GARCH) model which allows for non-zero conditional skewness in returns. Our findings imply that the BiN-GARCH model, which allows for time-variation in the conditional skewness and market price of risk, captures the expected positive risk–return relationship in eleven out of fourteen markets studied. In comparison, symmetric skewness models such as MIDAS or GARCH variants fail to capture positive and statistically significant market price of risk estimates. These results provide support for the growing literature on the necessity of modeling conditional higher moments in financial research.