Risk-Return Relationship Reinvestigated

Abstract

There is no conclusive evidence on the relationship between risk and return. Therefore we make an attempt to study the time-series relation between risk and return in two parts. One, we examine the link between market return and market risk. Second, we study the relationship between market return and average stock risk. We use the approach suggested by Goyal and Santa Clara (2003) for computing market risk and average stock risk. We use BSE-200 index data as well as BSE-500 companies' price data for the period January 1994 to June 2010. We find that average stock variance is not significant in predicting market returns. Further, we find that market variance has negative and insignificant coefficient in all cases except one where the coefficient is statistically significant at 10% level. Increasing integration of worldwide capital markets could be a possible reason for these insignificant coefficients.