Risk, Uncertainty, and Expected Returns
Abstract A conditional asset pricing model with risk and uncertainty implies that the time varying exposures of equity portfolios to the market and uncertainty factors carry positive risk premia. The empirical results from the size, book to market, momentum, and industry portfolios indicate that the conditional covariances of equity portfolios with market and uncertainty predict the time series and cross sectional variation in stock returns. We find that equity portfolios that are highly correlated with economic uncertainty proxied by the variance risk premium (VRP) carry a significant annualized 8% premium relative to portfolios that are minimally correlated with VRP.
Journal of Financial and Quantitative Analysis