What is the expected return on the market?

Martin, Ian ORCID: 0000-0001-8373-5317 (2017) What is the expected return on the market? Quarterly Journal of Economics, 132 (1). 367 - 433. ISSN 0033-5533

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Abstract

I derive a lower bound on the equity premium in terms of a volatility index, SVIX, that can be calculated from index option prices. The bound implies that the equity premium is extremely volatile and that it rose above 20% at the height of the crisis in 2008. The time-series average of the lower bound is about 5%, suggesting that the bound may be approximately tight. I run predictive regressions and find that this hypothesis is not rejected by the data, so I use the SVIX index as a proxy for the equity premium and argue that the high equity premia available at times of stress largely reflect high expected returns over the very short run. I also provide a measure of the probability of a market crash, and introduce simple variance swaps, tradable contracts based on SVIX that are robust alternatives to variance swaps.

Item Type:	Article
Official URL:	http://qje.oxfordjournals.org/
Additional Information:	© 2016 The Author © CC BY-NC-ND 4.0
Divisions:	Finance
Subjects:	H Social Sciences > HG Finance
JEL classification:	E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy G - Financial Economics > G1 - General Financial Markets
Date Deposited:	29 Jun 2016 16:09
Last Modified:	14 Nov 2024 21:54
Projects:	639744
Funders:	European Research Council
URI:	http://eprints.lse.ac.uk/id/eprint/67036

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