What Drives the Expected Return on a Stock: Short-Run or Long-Run Risk?

44 Pages Posted: 12 Feb 2018 Last revised: 4 Mar 2020

See all articles by Christian Dorion

Christian Dorion

HEC Montreal; Canadian Derivatives Institute

Adelphe Ekponon

University of Liverpool Management School

Alexandre Jeanneret

UNSW Business School

Date Written: May 4, 2018

Abstract

This paper addresses this question with an asset-pricing model featuring endogenous corporate policies. Long-run risk reflects a firm’s profit exposure to slowly-moving expected consumption growth, whereas short-run risk captures the exposure to frequent unexpected changes in consumption growth. Long-run risk reduces a firm’s optimal leverage while driving most of the equity risk premium. The contribution of short-run risk increases during expansions and for firms with higher idiosyncratic volatility, but remains similar across levels of default risk and systematic volatility. These findings contribute to understanding the expected return on a stock, both over time and in the cross-section.

Keywords: Equity risk premium, long-run risk, short-run risk, capital structure, asset pricing

JEL Classification: G12, G17, E44

Suggested Citation

Dorion, Christian and Ekponon, Adelphe and Jeanneret, Alexandre, What Drives the Expected Return on a Stock: Short-Run or Long-Run Risk? (May 4, 2018). Available at SSRN: https://ssrn.com/abstract=3116235 or http://dx.doi.org/10.2139/ssrn.3116235

Christian Dorion

HEC Montreal ( email )

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HOME PAGE: http://neumann.hec.ca/pages/christian.dorion/

Canadian Derivatives Institute ( email )

3000, chemin de la Côte-Sainte-Catherine
Montréal, Québec H3T 2A7
Canada

Adelphe Ekponon (Contact Author)

University of Liverpool Management School ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

HOME PAGE: http://adelpheekponon.com/

Alexandre Jeanneret

UNSW Business School ( email )

Sydney, NSW 2052
Australia

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