IS THE RISK-RETURN PARADOX STILL ALIVE?

Abstract

To date, the validity of empirical Bowman’s paradox papers that employ mean-variance approach for testing the risk/return relationship are inherently unverifiable and their results cannot be generalized. However, this problem can be overcome by developing an econometric model with two fundamental characteristics. The first one is the use of a time series model for each firm, avoiding the traditional cross-sectional analysis. The other one is to estimate a model with a single variable (the firm rate of return), but whose expectation and variance are mathematically related according to behavioral theories hypotheses, forming a heterocedastic model similar to “GARCH”. Our results agree with behavioral theories and show that these theories can also be carry out with market measures.