What is the Expected Return on a Stock?

2017 HONORABLE MENTION

Ian Martin, Ph.D., London School of Economics and Christian Wagner, Ph.D., Copenhagen Business School

There is, of course, an expansive literature concerned with determining future returns on assets.  The contribution of this paper is the derivation of a formula motivated by theory that calculates the expected return on a stock computed solely from index and stock option prices.  Unlike typical asset pricing models it does not require historical estimation of various parameters like factor loadings, which are inherently difficult to measure and prone to error. Interestingly, the authors find that the model performs well at various forecast horizons, both within and out of sample, and captures information beyond that of well-known predictors including beta, book-to-market, and momentum.  The authors argue that expected returns on individual stocks are more volatile than previously understood, both over time and across stocks.

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