Non-linear Tradeoff between Risk and Return: A Regime-switching Multi-factor Framework

This paper examines the risk-return trade-off in Spain during the last 15 years. The study is developed in a multi-factor framework where not only the market risk is considered but also potential changes in the investment opportunity set. Although previous studies find no clear evidence about a positive and significant relation between return and risk, favourable evidence can be obtained if a non-linear relation between return and risk is established. Despite the importance of the intertemporal hedging component in the risk premium demanded by investors, the evidence obtained is independent of the choice of the proxy used. Different patterns for the risk premium dynamics in low and high volatility periods are obtained, both in risk prices and risk (conditional second moments) patterns.