Journal of Financial and Quantitative Analysis

Research Articles

Risk-Return Tradeoff in U.S. Stock Returns over the Business Cycle

Henri Nyberga1

a1 Department of Political and Economic Studies, Economics, University of Helsinki, PO Box 17, Helsinki 00014, Finland, and HECER.


In the empirical finance literature, findings on the risk-return tradeoff in excess stock market returns are ambiguous. In this study, I develop a new qualitative response (QR)-generalized autoregressive conditional heteroskedasticity-in-mean (GARCH-M) model combining a probit model for a binary business cycle indicator and a regime-switching GARCH-M model for excess stock market return with the business cycle indicator defining the regime. Estimation results show that there is statistically significant variation in the U.S. excess stock returns over the business cycle. However, consistent with the conditional intertemporal capital asset pricing model (ICAPM), there is a positive risk-return relationship between volatility and expected return independent of the state of the economy.

(Online publication December 15 2011)


I thank Turan Bali (the referee), Hendrik Bessembinder (the editor), Markku Lanne, and Pentti Saikkonen as well as participants at the 16th International Conference on Computing in Economics and Finance in London (July 2010) and 25th Annual Congress of the European Economic Association in Glasgow (August 2010) for constructive comments. I am responsible for remaining errors. Financial support from the Academy of Finland and the OP-Pohjola Group Research Foundation is gratefully acknowledged. Previous drafts of the paper circulated under the title “QR-GARCH-M Model for Risk-Return Tradeoff in U.S. Stock Returns and Business Cycles.”