What is the Expected Return on the Market?*

2016/10/04 by Ian Martin · 564 citations
Economics, Econometrics and Finance · Mathematics · #Crash #Econometrics #Economics #Equity (law) #Equity premium puzzle #Financial Markets and Investment Strategies #Financial Risk and Volatility Modeling #Financial economics #Index (typography) #Mathematics #Proxy (statistics) #Risk premium #Statistics #Stochastic processes and financial applications #Stochastic volatility #Variance (accounting) #Variance risk premium #Variance swap #Volatility (finance) #Volatility risk premium

paper · pdf · doi:10.1093/qje/qjw034

published in The Quarterly Journal of Economics 132(1), 367-433 (Oxford University Press)

openalex publication_date 2016/10/04 · openalex created_date 2025/10/10 · openalex updated_date 2026/08/03

Abstract

Abstract I derive a lower bound on the equity premium in terms of a volatility index, SVIX, that can be calculated from index option prices. The bound implies that the equity premium is extremely volatile and that it rose above 20% at the height of the crisis in 2008. The time-series average of the lower bound is about 5%, suggesting that the bound may be approximately tight. I run predictive regressions and find that this hypothesis is not rejected by the data, so I use the SVIX index as a proxy for the equity premium and argue that the high equity premia available at times of stress largely reflect high expected returns over the very short run. I also provide a measure of the probability of a market crash, and introduce simple variance swaps, tradable contracts based on SVIX that are robust alternatives to variance swaps.

Citations

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• Association of Random Variables, with Applications
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• Presidential Address: Discount Rates
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• Stock valuation during the COVID-19 pandemic: An explanation using option-based discount rates. [europepmc]
• Equity premium forecasting with reliability-screened forward-looking signals. [europepmc]

Related

• Equity Premium Prediction: Taking into Account the Role of Long, even Asymmetric, Swings in Stock Market Behavior
• Estimating the Stochastic Discount Factor from Option Prices and Predicting the Equity Premium
• Market Expectations in the Cross‐Section of Present Values
• Beyond the Traditional VIX: A Novel Approach to Identifying Uncertainty Shocks in Financial Markets
• Risk and Return models for Equity Markets and Implied Equity Risk Premium