Risky Relations - A study of the relationship between expected stock returns and volatility on the international market

Abstract: This econometric study examines the relationship between expected returns and volatility in ten industrialized countries. It includes three models; GARCH-M, EGARCH-M and the PARCH-M model. Furthermore, it investigates if the results change with the use of several time intervals, different data frequency and the inclusion of macroeconomic variables into the models. The results provide evidence that no significant relationship between volatility and expected return could be identified on the international market in the long term. In the short term, a weak and unstable relationship could be found in some markets. Furthermore, the results suggest that there generally exists a positive short term relationship and a negative long term relationship between expected returns and volatility. This paper also found evidence that volatility explains the expected return in the long term in a greater extent than it does on the short term.