Expected Stock Market Returns and Volatility: Three Decades Later

Abstract

We replicate the findings of French, Schwert, and Stambaugh (FSS 1987) almost exactly. Consistent with FSS, we find modest evidence of a positive relation between market risk premium and the expected market volatility and strong evidence of a negative relation between market excess returns and the unexpected change in market volatility during 1928-1984. These results persist during 1985-2018 and are robust to alternative data and model specifications. We extend the analysis to 23 developed countries and find qualitatively similar results. We show that the risk-return tradeoff is stronger during expansions than during recessions and does not vary significantly with investor sentiment.