Discussion paper

DP9698 Regime Switches in the Risk-Return Trade-off

This paper deals with the estimation of the risk-return trade-off. We use a MIDAS model for the conditional variance and allow for possible switches in the risk-return relation through a Markov-switching specification. We find strong evidence for regime changes in the risk-return relation. This finding is robust to a large range of specifications. In the first regime characterized by low ex-post returns and high volatility, the risk-return relation is reversed, whereas the intuitive positive risk-return trade-off holds in the second regime. The first regime is interpreted as a "flight-to-quality" regime.


Ghysels, E and M Marcellino (2013), ‘DP9698 Regime Switches in the Risk-Return Trade-off‘, CEPR Discussion Paper No. 9698. CEPR Press, Paris & London. https://cepr.org/publications/dp9698