What is the expected return on a stock?

Martin, Ian ORCID: 0000-0001-8373-5317 and Wagner, Christian (2016) What is the expected return on a stock? Financial Markets Group Discussion Papers (760). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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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.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 2016 The Authors
Divisions:	Finance
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing; Futures Pricing
Date Deposited:	02 Jun 2023 09:39
Last Modified:	01 Oct 2024 03:20
URI:	http://eprints.lse.ac.uk/id/eprint/118957

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