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Market-Based Solutions to Vital Economic Issues
Research
Dec 8, 2017

Intermediary Asset Pricing and the Nonlinear Relation between Volatility and the Equity Size Premium

Abstract

Over 1960 to 2017, we show that a positive risk premium from holding high-beta stocks (versus low-beta stocks) and small-cap stocks (versus large-cap stocks) is reliably earned only after the expected stock-market volatility breaches an approximate top-quintile threshold. The high conditional average returns with this nonlinear risk-return phenomenon are persistently evident over months t+1 to t+6 following a volatility-threshold breach in month t-1. Conversely, this nonlinear risk-return phenomenon is not comparably evident for the Fama-French HML, RMW, and CMA factors. We present additional evidence that suggests habit-consumption utility, intermediary asset pricing, and stochastic-volatility asset pricing are likely contributing channels.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.


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