Business Cycle Variation in the Risk-Return Trade-Off

Lustig, Hanno N.; Verdelhan, Adrien

doi:10.2139/ssrn.1670715

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Business Cycle Variation in the Risk-Return Trade-Off

Journal of Monetary Economics, Forthcoming

35 Pages Posted: 2 Sep 2010 Last revised: 13 Nov 2012

See all articles by Hanno N. Lustig

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Adrien Verdelhan

National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: February 10, 2011

Abstract

In the United States and other Organisation for Economic Co-operation and Development (OECD) countries, the expected returns on stocks, adjusted for volatility, are much higher in recessions than in expansions. We consider feasible trading strategies that buy or sell shortly after business cycle turning points that are identifiable in real time and involve holding periods of up to one year. The observed business cycle changes in expected returns are not spuriously driven by changes in expected near-term dividend growth. Our findings imply that value-maximizing managers face much higher risk-adjusted costs of capital in their investment decisions during recessions than expansions.

Keywords: Risk Premia, Sharpe Ratio

JEL Classification: E44, G12

Suggested Citation: Suggested Citation

Lustig, Hanno N. and Verdelhan, Adrien and Verdelhan, Adrien, Business Cycle Variation in the Risk-Return Trade-Off (February 10, 2011). Journal of Monetary Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1670715 or http://dx.doi.org/10.2139/ssrn.1670715