Abstract

This paper examines empirically the trade-off between risk (conditional volatility) and expected returns for the Saudi Arabian and Egyptian stock indices over the period of January 1, 2007 to December 30, 2011. The empirical analysis of the paper is carried out by means of the generalized autoregressive conditional heteroscedastic (GARCH) in mean methodology including both symmetric (GARCH-M) and asymmetric (EGARCH-M) models. The results show that the dynamic risk-return relationship is quite different between Saudi Arabian and Egyptian stock markets. A negative but insignificant relationship between expected returns and conditional volatility is found for daily returns in Egypt. In contrast, the conditional mean of the stock returns is positively but insignificantly related to its conditional variance in Saudi stock market a result which is consistent with the theory of a positive risk premium on stock indices which states that higher returns are expected for assets with higher level of risk. The findings of the paper are useful for financial decision making.

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