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Generalized Bounds on the Conditional Expected Excess Return on Individual Stocks
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Description: https://dx.doi.org/10.2139/ssrn.3565130 : We derive generalized bounds on conditional expected excess returns. The bounds deliver consistent expected returns for individual and index-type assets, are conditionally tight, account for all risk-neutral moments of returns, and outperform runner-up models for out-of-sample predictions. Bounds calibrated to realized returns correspond to reasonable risk aversion and prudence. On average, expected stock returns given by the bounds decrease on FOMC days and even weeks of the FOMC cycle. However, using a composite sensitivity index based on asset characteristics, we also identify stocks experiencing an increase in expected returns. Cross- sectional tests deliver a reasonable market risk premium.
The computation of the generalized lower bounds requires assumptions about risk preferences, such as relative risk aversion (RRA), and temperance (skewness preference). The provided dataset is computed under assumption of relative risk aversion of 2.0, half prudence of 1.0 (for glb2, based on the second-order Taylor-series expansion), and temperance of 4 (for glb3, based on the third-order Taylor…
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