Eric Falkenstein has a great blog entry on the relationship between risk and return, riffing off my post on what stock-market volatility should do to investors’ asset allocation. Essentially, he says, the idea that returns increase with risk is simply wrong:

Steve Sharpe and Gene Amromin found that in questionnaires investors tended to have higher return expectations when they forecast volatility as being relatively low, and lower return expectations when they forecast lower volatility. Exactly the opposite of what they should be thinking. This isn’t a missing a constant in the second decimal, rather, screwing up the sign.

As this is consistent with the theme of my book Finding Alpha, I thought this paper was awesome, and asked Steve Sharpe why it wasn’t...