What is the expected return on the market?

Martin, Ian (2016) What is the expected return on the market? Quarterly Journal of Economics . ISSN 0033-5533 (In Press)

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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
Library of Congress subject classification:	H Social Sciences > HG Finance
Sets:	Departments > Finance
Project and Funder Information:	Project ID Funder Name Funder ID 639744 European Research Council http://dx.doi.org/10.13039/501100000781
Date Deposited:	29 Jun 2016 16:09
URL:	http://eprints.lse.ac.uk/67036/

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