The Risk - Return Trade - off in Europe: Is There a Pro - cyclical Risk Aversion ?

Abstract

This paper analyzes the risk-return trade-off in European equities considering both temporal and cross-sectional dimensions. We introduce not only the market portfolio but also 15 industry portfolios comprising the entire market. The consideration of this pooled analysis (temporal and cross-sectional) let us obtain a positive and significant relationship between return and risk supporting the doctrine of the mainstream in the field. This result is even more evident when the estimation is conditioned on the main crises periods highlighting that the estimated risk-aversion parameter is higher in boom periods than in recession periods, reflecting a procyclical risk aversion in the investor profile.

This paper analyzes the risk-return trade-off in European equities considering both temporal and cross-sectional dimensions. We introduce not only the market portfolio but also 15 industry portfolios comprising the entire market. The consideration of this pooled analysis (temporal and cross-sectional) let us obtain a positive and significant relationship between return and risk supporting the doctrine of the mainstream in the field. This result is even more evident when the estimation is conditioned on the main crises periods highlighting that the estimated risk-aversion parameter is higher in boom periods than in recession periods, reflecting a procyclical risk aversion in the investor profile.