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What Is the Expected Return on a Stock?

Research output: Research - peer-reviewPaper

We derive a formula that expresses the expected return on a stock in terms of the risk-neutral variance of the market and the stock's excess risk-neutral variance relative to the average stock. These components can be computed from index and stock option prices; the formula has no free parameters. We test the theory in-sample by running panel regressions of stock returns onto risk-neutral variances. The formula performs well at 6-month and 1-year forecasting horizons, and our predictors drive out beta, size, book-to-market, and momentum. Out-of-sample, we find that the formula outperforms a range of competitors in forecasting individual stock returns. Our results suggest that there is considerably more variation in expected returns, both over time and across stocks, than has previously been acknowledged.

Publication information

Original languageEnglish
Publication date2017
Number of pages57
StatePublished - 2017
Event2017 Annual Meeting of the Society for Economic Dynamics - Edinburgh, United Kingdom
Duration: 22 Jun 201724 Jun 2017
https://www.economicdynamics.org/sedam_2017/

Conference

Conference2017 Annual Meeting of the Society for Economic Dynamics
CountryUnited Kingdom
CityEdinburgh
Period22/06/201724/06/2017
Internet address

ID: 50425389