Regime switches in the risk–return trade-off

•We estimate the risk-return trade-off with a MS-MIDAS model.•We find strong evidence for regime changes in the risk-return relation.•The first regime is interpreted as a “flight-to-quality” regime.•In first regime, the risk-return relation is reversed.•The intuitive positive risk-return trade-off holds in the second regime.

This paper deals with the estimation of the risk–return trade-off. We use a MIDAS model for the conditional variance and allow for possible switches in the risk–return relation through a Markov-switching specification. We find strong evidence for regime changes in the risk–return relation. This finding is robust to a large range of specifications. In the first regime characterized by low ex-post returns and high volatility, the risk–return relation is reversed, whereas the intuitive positive risk–return trade-off holds in the second regime. The first regime is interpreted as a “flight-to-quality” regime.