What Is the Expected Return on a Stock?

Ian Martin, Christian Wagner

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

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.
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.

Conference

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

Cite this

Martin, I., & Wagner, C. (2017). What Is the Expected Return on a Stock?. Paper presented at 2017 Annual Meeting of the Society for Economic Dynamics , Edinburgh, United Kingdom.
Martin, Ian ; Wagner, Christian. / What Is the Expected Return on a Stock?. Paper presented at 2017 Annual Meeting of the Society for Economic Dynamics , Edinburgh, United Kingdom.57 p.
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abstract = "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.",
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note = "null ; Conference date: 22-06-2017 Through 24-06-2017",
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Martin, I & Wagner, C 2017, 'What Is the Expected Return on a Stock?' Paper presented at, Edinburgh, United Kingdom, 22/06/2017 - 24/06/2017, .

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

2017. Paper presented at 2017 Annual Meeting of the Society for Economic Dynamics , Edinburgh, United Kingdom.

Research output: Contribution to conferencePaperResearchpeer-review

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T1 - What Is the Expected Return on a Stock?

AU - Martin,Ian

AU - Wagner,Christian

PY - 2017

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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.

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Martin I, Wagner C. What Is the Expected Return on a Stock?. 2017. Paper presented at 2017 Annual Meeting of the Society for Economic Dynamics , Edinburgh, United Kingdom.