The impact of global financial market uncertainty on the risk-return relation in the stock markets of G7 countries. Issue 1 (6th March 2017)

• Record Type: Journal Article
• Authors: Loudon, Geoffrey
• Is Part Of: Studies in economics and finance. Volume 34:Issue 1(2017)
• Page Start: 2
• Page End: 23
• Publication Date: 2017-03-06
• Subjects: Risk and return -- Regime-switching -- Asset pricing -- Market uncertainty; G12 -- G13; Economics -- Periodicals; Finance -- Periodicals; 330
• DOI: 10.1108/SEF-05-2013-0069
• Languages: English
• ISSNs: 1086-7376

Abstract

Abstract : Purpose: This paper aims to investigate the effect of global financial market uncertainty on the relation between risk and return in G7 stock markets. Design/methodology/approach: Market uncertainty is quantified using a probability-based measure derived from a regime-switching model in which the state transition probabilities are time-varying in response to leading economic indicators. Time variation in the risk return relation is estimated using a GARCH-M model. Findings: While the regime-switching model successfully distinguishes between crisis and normal states, there remains substantial variability through time in the level of uncertainty about which state prevails. Results show that a strong negative relation exists between this uncertainty and the reward-to-variability ratio across all G7 stock markets. This finding is qualitatively consistent at both monthly and weekly horizons. Originality/value: Extant evidence on the risk-return relation is conflicting. Most papers assume the relation is time constant. Allowing the reward-to-variability ratio to vary through time in response to return regime uncertainty increases the understanding of asset pricing. It also has important implications for asset allocation decisions by investors.