The Relation between Expected Returns and Volatility in the Brazilian Stock Market

Abstract

This paper applies the Markov switching regression model of stock returns with volatility feedback of Turner, Startz and Nelson (1989), suitably extended to incorporate endogenous regime shifts, as in Kim, Piger and Startz (2008), to examine the intertemporal relationship between the risk premium and volatility in the Brazilian stock market over the period 1995-2011. The results suggest that there is a positive relationship between the risk premium and the expected volatility once the volatility feedback effect is taken into account. Unanticipated increases in volatility, in contrast, have a negative impact on the risk premium. This negative impact increasesby 50% when I account for endogeneity of regime shifts.