### Abstract

Language | English |
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Place of Publication | London |

Publisher | The London School of Economics and Political Science, LSE |

Number of pages | 69 |

State | Published - Nov 2016 |

Series | Financial Markets Group Discussion Paper |
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Number | 760 |

ISSN | 0956-8549 |

### Cite this

*What is the Expected Return on a Stock?*London: The London School of Economics and Political Science, LSE. Financial Markets Group Discussion Paper , No. 760

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**What is the Expected Return on a Stock?** / Martin, Ian; Wagner, Christian.

Research output: Working paper › Research

TY - UNPB

T1 - What is the Expected Return on a Stock?

AU - Martin,Ian

AU - Wagner,Christian

PY - 2016/11

Y1 - 2016/11

N2 - 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.

AB - 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.

M3 - Working paper

BT - What is the Expected Return on a Stock?

PB - The London School of Economics and Political Science, LSE

CY - London

ER -