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What is the expected return on the market?

Martin, Ian (2017) What is the expected return on the market? Quarterly Journal of Economics, 132 (1). pp. 367-433. ISSN 0033-5533

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Identification Number: 10.1093/qje/qjw034

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
Sets: Departments > Finance
Date Deposited: 29 Jun 2016 16:09
Last Modified: 20 Mar 2019 03:07
Projects: 639744
Funders: European Research Council
URI: http://eprints.lse.ac.uk/id/eprint/67036

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