Risk-return Relationship Research Articles

Physical climate change risk and ESG green premium

ABSTRACT We build an asset pricing model that incorporates climate change risk and firms’ ESG engagement to analyse their interactive effects on equity returns. Our model shows that a firm’s ESG engagement has three channels for influencing stock returns: its direct impact on resisting climate change risk, indirect reduction in systematic risk and attraction of green preference, and the empirical evidence shows that both risk–return relation and ESG engagement are priced. We also point out an inevitably negative and convex relation between the market Sharp Ratio and stocks market beta in an economy with climate change risk.

Mapping Risk–Return Linkages and Volatility Spillover in BRICS Stock Markets through the Lens of Linear and Non-Linear GARCH Models

This paper explores the influence of the risk–return relationship and volatility spillover on stock market returns of emerging economies, with a particular focus on the BRICS countries. This research is undertaken in a context where discussions on de-dollarization and the expansion of BRICS membership are gaining momentum, making it a novel and distinct exercise compared to prior studies. Utilizing econometric techniques to investigate daily market returns from 1 April 2008 to 31 March 2023, a period that witnessed major events like the global financial crisis, the COVID-19 pandemic, and the Russia–Ukraine conflict, linear and non-linear models like ARCH, GARCH, GARCH-M, EGARCH, and TGARCH, are employed to assess stock return volatility behaviour, assuming a Gaussian distribution of error terms. The diagnostic test confirms that the distribution is non-normal, stationary, and heteroscedastic. The key findings indicate a lack of the risk–return relationship across all BRICS stock markets, except for South Africa; a more pronounced effect of unpleasant news over pleasant news; a slow mean-reverting process in volatility; the EGARCH model is the best fit model as evidenced by a higher log likelihood and lower Akaike information criterion and Schwardz information criterion parameters; and finally, the presence of significant bidirectional and unidirectional spillover effects in the majority of instances. These findings are valuable for investors, regulators, and policymakers in enhancing returns and mitigating risk through portfolio diversification and informed decision making.

Risk and Return Analysis of Stocks of Nepalese Commercial Banks

This research article analyzes the impact of risk and return of Nepalese commercial bank stocks on portfolio returns to assist investors in making informed investment decisions. It aims to examine the effects of individual bank stock returns, risks, market return, and market risk (beta) on overall portfolio performance. The study utilizes a quantitative approach, employing descriptive statistics, comparative (trend) analysis, correlation analysis, and hypothesis testing. Secondary data was collected from 18 commercial banks in Nepal, including post-merger banks, covering the fiscal years from 2015/16 to 2021/22. Statistical tools such as SPSS and EViews were used for analysis. The findings indicate that investors seeking higher returns might consider Prabhu Bank, which offers high mean returns but also comes with higher volatility. In contrast, risk-averse investors may prefer banks like NMB and Nabil, which provide lower mean returns but more stable performance. Notably, this research contributes to the understanding of the risk-return relationship in the context of 18 Nepalese commercial banks post-merger, providing new insights for investors. This study highlights the importance of analyzing individual bank stocks and their associated risks for portfolio construction. By understanding the dynamics of risk and return, investors can optimize their investment strategies and enhance portfolio performance. Overall, this research fills a gap in existing literature by focusing on the Nepalese commercial banking sector and its implications for investor decision-making. The insights gained from this study can guide investors in navigating the complexities of the stock market, ultimately leading to more informed and strategic investment choices. Future research could expand on this work by exploring additional factors influencing stock performance and investor behavior in the Nepalese context.

The Left-tail Risk and the Cross-section of Stock Returns: Evidence from China

As a matter of fact, left-tail risk is a common risk in stock market. This study examines the linear correlation considering Value-at-Risk (VaR) and future stock returns within context of the Chinese main board stocks, particularly during periods marked by significant left-tail risk. Processing data from March 2014 to March 2024, this study concentrate to daily and monthly cross-section returns, along with other financial statistics. A suitable Fama-Macbeth regression using in this paper to exam the significance of left-tail risk. The key focus is to investigate the effect of VaR concerning future stock returns under downside market conditions, as indicated by the recent 23% drop in China’s benchmark CSI 300 index. The regression analysis indicates a significant negative correlation between VaR and future stock returns, suggesting that higher potential losses as indicated by VaR correspond with lower future returns. This outcome is contrary to traditional asset pricing theories which posit a positive risk-return relationship. The findings will attract attention of investors to consider extreme risk management of public stocks and contributes to the ongoing discussion on risk assessment in financial markets by highlighting the importance of integrating robust risk management tools like VaR in investment strategies, especially in volatile markets.

PERFORMANCE EVALUATION OF EXCHANGE TRADED FUNDS (ETFs) IN INDIA: A REVIEW OF SELECTED LITERATURE

The panorama of investment options provided to investors by Exchange Traded Funds (ETFs) and their remarkable rise since their introduction in the nation have made an assessment of existing literature on ETFs in India necessary. In the light of these developments, the present study focuses on previous research conducted by different researchers to comprehend the performance of equity based mutual funds in India. The aim of this paper is to examine the corpus of work that may be found in both national and international peer-reviewed journals, seminars and conference proceedings. It look at abroad range of research on topics such as risk return relationship, investment goals, investment time horizon, investment kind and market volatility that support investing in equity based mutual fund schemes. It has been found that most of the exchange traded funds (ETFs) fared better than their underlying indices.

Unraveling the puzzling risk–return relationship: Distinctive roles of government involvement in venture capital investment

AbstractResearch SummaryGovernment involvement plays a significant role in fostering entrepreneurship. We examine how government involvement in venture capital (VC) investments shapes the decoupling between risk‐taking and investment returns. We distinguish government involvement through state ownership (GVC) and personal political connections (connected VC). We theorize that government involvement through GVC is associated with the downside risk–return paradox, that is, concurrent higher risk‐taking and lower‐than‐expected returns. In contrast, government involvement through connected VCs is linked to the upside risk–return paradox, that is, concurrent lower risk‐taking and higher‐than‐expected returns. Our theoretical predictions receive general support from analyses using longitudinal data from VC firms in China. Our study sheds light on the heterogeneity in the decoupling between risk and return and the underlying mechanisms through which governments influence entrepreneurship.Managerial SummaryGovernments often seek to promote entrepreneurship; yet, their involvement in start‐ups tends to deviate from the conventional wisdom of a positive risk–return association. Government‐owned venture capital (VC) firms tend to take greater risks and invest in earlier‐stage start‐ups, but yield lower returns from their investments. Conversely, VC firms that have personal ties to government officials tend to take lower risks and prefer later‐stage start‐ups, yet achieve higher returns. These intriguing findings reveal the complexities of government participation in entrepreneurial activities and offer valuable insights for policy formulation. In addition, our findings highlight the importance for entrepreneurs to recognize diverse goals and resources in government involvement. Considering this when seeking external financing is helpful in positioning start‐ups for growth and success.

The risk–return tradeoff among equity factors

We examine the time-series risk–return tradeoff among equity factors. We obtain a positive tradeoff for profitability and investment factors, which is consistent with the APT. Such relationship subsists when we control by the covariance with the market factor, which represents consistency with Merton’s ICAPM. Critically, we obtain an insignificant risk–return relationship for the market and other factors. The tradeoff is weaker among international equity markets. The out-of-sample forecasting power tends to be economically significant for the investment and profitability factors. Our results suggest that the risk–return tradeoff is stronger within segments of the stock market than for the whole.

Why do firms with no leverage still have leverage and volatility feedback effects?

The leverage effect hypothesis of Black (1976) and Christie (1982) posits that time-series variation in debt causes an inverse relation between stock return volatility and stock returns. Hasanhodzic and Lo (2019) test this hypothesis in a novel sample of firms with no debt and yet they still find an inverse relation, motivating them to espouse volatility feedback as an alternative. Under standard assumptions governing the risk-return relation from the asset pricing literature, I explain why the stock returns of all-equity-financed firms will still have leverage effects on par with those of debt-financed firms and why the absence of debt at the firm level has no bearing on the leverage and volatility feedback hypotheses.

Capital Asset Pricing Model: A Renewed Application on S&P 500 Index

Capital Asset Pricing Model: A Renewed Application on S&P 500 Index

Multifactor conditional equity premium model: Evidence from China's stock market

There is mixed evidence of a positive relationship between the stock market risk and return. We reexamine this critical implication of asset pricing theory using fresh data from China's stock market, which is largely segmented from the rest of the global financial market. Using formal variable selection methods and a comprehensive set of predictor variables, we identify conditional market variance, scaled market prices, and inflation as crucial determinants of equity premiums. The estimated simple risk-return relationship exhibits downward omitted variable bias, which underlines the importance of considering multiple factors to explain the variation in equity premiums. We cannot wholly attribute the three-factor conditional equity premium model to data mining, as Guo, Sanni, and Yu (2022) select the same model for the U.S. stock market. These findings challenge existing asset pricing models and provide valuable guidance for future theoretical research.

The Intraday Heterogeneity and Risk Pricing Reversal Between Day and Night: Evidence from China

ABSTRACT Using a large panel of high-frequency trading data, this article investigates the intraday heterogeneity of risk pricing process in the Chinese stock market. Our research reveals that the financial assets in China exhibit intraday beta variation: high/low market risk level assets, with beta values above/below unity, tend to have downward/upward sloping beta trajectories across the intraday trading periods. We confirm a trend reversal of the risk-return relation between day and night in the Chinese market: the assets’ intraday returns are negatively correlated with their market risk level, whereas their overnight returns are positively correlated with their risk level. Further investigation shows a connection between the intraday beta variation and the day-night reversal anomaly, and the risk-return reversal between day and night can be partially explained by the intraday beta variation of financial assets. After controlling for the intraday beta variation, the risk-return reversal anomaly between day and night becomes less pronounced in the Chinese market.

State-dependent intertemporal risk-return tradeoff: Further evidence

We suggest that the intertemporal risk-return tradeoff is not necessarily positive but rather state dependent. We further explore the state dependent risk-return relation by examining how the positive risk-return relation is distorted in response to various market conditions, including extreme price changes, differing levels of investor sentiment, the introduction of stock options, and throughout business cycles. The tendency for uninformed investors to be optimistic (pessimistic) in response to good (bad) market news cause overpricing (underpricing), and the resulting trade activity of arbitrageurs that distorts the positive risk-return tradeoff, is documented consistently across these environments. We find that the attenuation (reinforcement) of the positive risk-return relation under investors’ optimistic (pessimistic) expectations is stronger in high (low) sentiment periods, in the presence of extreme returns, in the period after stock options became available, and during expansionary periods. We argue that the asymmetric intertemporal risk-return relation is a consequence of rational arbitrageurs’ trading to exploit mispricing through the selling of overpriced stocks conditional on good news and buying underpriced stocks conditional on bad news.

Seasonal variation in risk and return trade‐off

AbstractExisting studies show that firms with large macroeconomic risk do not earn higher returns, incompatible with the theoretical predictions of standard economic models. Using a broad set of macro‐related factors, we find the January seasonality of the macroeconomic risk–return relation. Firms with high macro risk deliver higher returns than firms with low risk in January, that is, the positive risk–return trade‐off holds. Conversely, the negative risk–return relation is observed in non‐January months. The seasonal variation in the macro risk–return relation cannot be explained by existing January effects, including the tax‐loss selling, window dressing, and pronounced gambling preference around New Year.

An aspirational perspective on the negative risk-return relationship

The existence of a negative risk-return relationship challenges the conventional wisdom of finance, which typically assumes a positive correlation between risk and return. Reference-dependent preferences, motivated by prospect theory, offer a possible explanation for this negative risk-return relation. However, as we demonstrate in this paper prospect theory does not provide a general explanation for this puzzle. We show that the expected utility theory with an aspiration level can effectively account for this phenomenon.

Comparative Analysis and Research of Investment Portfolio Management Models

Portfolio management plays a significant role in the world of finance and investing, offering benefits and contributions to both individual investors and institutions. Researchers use many mathematical models to make informed decisions about how to allocate and manage investments within a portfolio to optimize risk versus return trade-off based on the investors preference and constraints. This paper primarily employs the literature review methodology and comparative analysis methodology. Firstly, it collects, summarizes, and analyzes multiple papers on portfolio management models, including Markowiz Mean-Variance Model, Capital Market Line (CML), Arbitrage Pricing Theory (APT) and Capital Asset Pricing Model (CAPM) with the origin of the models, their key assumptions, components, and applications. Additionally, this paper also utilizes comparative analysis by comparing the similarities, differences, and respective downsides and benefits of the four main research models. Through this comparison, the paper investigates the relationships and application distinctions among the models. As a result, these models evolve and refine over time, with some building on others. CAPM extends the Markowitz Model by introducing the risk-free rate and market portfolio as benchmarks, simplifying the risk-return relationship, and introducing systematic risk. The Capital Market Line (CML), derived from CAPM, illustrates efficient portfolios made up of both market and risk-free assets and shows the risk-return trade-off. APT, a later model, can be seen as an extension of CAPM.

An Econometric Study on Volatility Clusters, Dynamic Risk Return Relationship, and Asymmetry in Bitcoin Returns

The most sought-after cryptocurrency sector is facing dicey environment in India due to stringent ideology of its government that put Indian investors in dilemma in envisaging this sector as a virtuous investment avenue. The investors are very curious for this sector and their curiosity aroused the need for its evaluation in terms of risk-return dynamics in contemporary scenario. The present study is an endeavor to econometrically explore volatility clusters, dynamic risk return relationship, and asymmetry in Bitcoin return series covering the period from August 2010 to February 2022. The results of Augmented Dickey–Fuller test, Ng–Perron tests, Ljung Box Q test, Engle’s ARCH, and White test asserted that the Bitcoin return series is stationary and has apparent volatility clusters in it. The estimates from GARCH-M model confirmed the absence of risk return relationship and the estimates from ARMA-EGARCH model confirmed the presence of asymmetry (leverage effect) in Bitcoin return series. However, the results of ARMA-TARCH model confirmed the absence of asymmetry in the series and further diagnostic checking asserted that ARMA- TARCH model is the best fitted model. These estimations may help the investors in comprehending risk-return dynamics of investment in Bitcoins for framing better hedging strategy in contemporary scenario.

Does Risk Return Trade-off Hold in Base Metal and Bullion Commodity Assets? A Bayesian Change Point Analysis

The risk-return trade-off is fundamental to portfolio investing whose stability is critical for portfolio optimisation. Since the relationship is dynamic, the portfolio manager should know the point of change and, thereafter duration of the changed period with certainty. First, we have done Bayesian change point analysis, and then based on the analysis, the study identifies the regimes having equal statistical variance along with the corresponding average return in two most popular commodities, that is, copper and gold. It is found that risk-return trade-off is not stable. Further, in a higher volatility regime, only gold can be considered as a diversifiable commodity because a positive risk-return trade-off holds. But in a low volatility regime, both commodities lose their diversification properties as the risk-return relation becomes negative.

State-dependent volatility feedback effect in the ICAPM

Considering that risk-averse investors revise their expectations in response to changes in both expected and unexpected volatility, we hypothesize and demonstrate that an unexpectedly high (low) volatility shock causes an increase (decrease) in risk premium. Using a novel approach to endogeneity issues, we utilize a state dependent, ICAPM to measure volatility effects on risk-return relationships. Our empirical results show that the volatility feedback effect strengthens (attenuates) the positive risk-return relation under bad (good) news. Furthermore, the volatility feedback effect under the combined conditions of bad news and a high unexpected volatility causes an extremely heightened level of the risk-return tradeoff.

Toward an economic reformulation of public pension funding

Abstract We propose an economic reformulation of contribution policy integrating: (1) formalization of sustainability as the steady-state contribution rate, incorporating both the expected return on risky assets and a low-risk discount rate for liabilities; (2) derivation of contribution adjustment policies required for convergence toward the target funded ratio and contribution rate; and (3) a stylized optimization framework for simultaneous determination of the target portfolio return and funded ratio. This analysis provides new theoretical insights into the basis for pre-funding vs. pay-as-you-go, resting on the convexity of the long-run risk–return relationship, and also potentially practical guidelines for contribution policy.

Do the rich gamble in the stock market? Low risk anomalies and wealthy households

Contrary to the theoretical principle that higher risk is compensated with higher expected return, the literature shows that low-risk stocks outperform high-risk stocks. Using a large-scale household dataset, we provide an explanation for this puzzling result that the anomalous negative risk-return relation is only confined to those stocks predominantly held by rich households, whereas the anomaly disappears for stocks held by non-rich households and institutional investors. We find that social status concern of rich households and the induced lottery preference explain wealthy investors’ demand for high-risk stocks, leading to overpricing and low future returns for such stocks.