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Title: An Intertemporal CAPM with Stochastic Volatility

Author(s): John Y Campbell, Stefano W Giglio, Christopher Polk and Robert Turley

Publication Date: June 2015

Keyword(s): ICAPM, stochastic volatility, time-varying expected returns and value premium

Programme Area(s): Financial Economics

Abstract: This paper studies the pricing of volatility risk using the first-order conditions of a long-term equity investor who is content to hold the aggregate equity market rather than tilting towards value stocks and other equity portfolios that are attractive to short-term investors. We show that a conservative long-term investor will avoid such overweights in order to hedge against two types of deterioration in investment opportunities: declining expected stock returns, and increasing volatility. Empirically, we present novel evidence that low-frequency movements in equity volatility, tied to the default spread, are priced in the cross-section of stock returns.

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Bibliographic Reference

Campbell, J, Giglio, S, Polk, C and Turley, R. 2015. 'An Intertemporal CAPM with Stochastic Volatility'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10681