The Risk and Required Return of Common Stock following Major Price Innovations

This paper presents empirical evidence demonstrating that the risk and expected returns of common stocks typically change in the aftermath of large price movements. When temporary changes in uncertainty follow major financial events, subsequent stock returns should be positively correlated with the shift in return volatility. This prediction is strongly supported by the data on more than 9,100 daily price change events during 1962–1985. Moreover, the data also suggest that ex ante returns on common stocks may incorporate a premium for increases in parameter uncertainty associated with the events.