A New Approach to Measuring Riskiness in the Equity Market: Implications for the Risk Premium

Fisher College of Business Working Paper No. 2012-03-009

Charles A. Dice Center Working Paper No. 2012-9

61 Pages Posted: 10 May 2012 Last revised: 6 Sep 2013

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - McDonough School of Business

Nusret Cakici

Fordham university

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: September 5, 2013

Abstract

We introduce a new approach to measuring riskiness in the equity market. We propose option implied and physical measures of riskiness and investigate their performance in predicting future market returns. The predictive regressions indicate a positive and significant relation between time-varying riskiness and expected market returns. The significantly positive link between aggregate riskiness and market risk premium remains intact after controlling for the S&P500 index option implied volatility (VIX), aggregate idiosyncratic volatility, and a large set of macroeconomic variables. We also provide alternative explanations for the positive relation by showing that aggregate riskiness is higher during economic downturns characterized by high aggregate risk aversion and high expected returns.

Keywords: Time-varying riskiness, risk-neutral measures, physical measures, expected returns, equity premium

JEL Classification: G11, G12, G14, G33

Suggested Citation

Bali, Turan G. and Cakici, Nusret and Chabi-Yo, Fousseni, A New Approach to Measuring Riskiness in the Equity Market: Implications for the Risk Premium (September 5, 2013). Fisher College of Business Working Paper No. 2012-03-009, Charles A. Dice Center Working Paper No. 2012-9, Available at SSRN: https://ssrn.com/abstract=2055380 or http://dx.doi.org/10.2139/ssrn.2055380

Turan G. Bali (Contact Author)

Georgetown University - McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

Nusret Cakici

Fordham university ( email )

113 West 60th Street
New York, NY 10023
United States
2017473227 (Phone)
07446 (Fax)

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

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