Posts Tagged ‘risk premium


Paper: Equity Yields

Equity Yields

We study a new data set of prices of traded dividends with maturities up to 10 years across three world regions: the US, Europe, and Japan. We use these asset prices to construct equity yields, analogous to bond yields. We decompose these yields to obtain a term structure of expected dividend growth rates and a term structure of risk premia, which allows us to decompose the equity risk premium by maturity. We find that both expected dividend growth rates and risk premia exhibit substantial variation over time, particularly for short maturities. In addition to predicting dividend growth, equity yields help predict other measures of economic growth such as consumption growth. We relate the dynamics of growth expectations to recent events such as the financial crisis and the earthquake in Japan.

Link al Paper


Paper: Mercados de Bonos, riesgo y correlación

International Bond Risk Premia

We identify local and global factors across international bond markets that are poorly spanned by the traditional level, slope and curvature factors but have strong forecasting power for future bond excess returns. Local and global factors are jointly significant predictors of bond returns, where the global factor is closely linked to US bond risk premia and international business cycles. Motivated by our results, we estimate a no-arbitrage affine term structure model for each country in which movements in risk premia are driven by one local and one global factor. Yield loadings for the two factors are estimated to be close to zero while shocks to risk premia account for a small fraction of yield variance. This suggests that the cross-section of yields conveys little information about the return-forecasting factors. We show that shocks to global risk premia cause offsetting movements in expected returns and expected future short-term interest rates, leaving current yields little affected. Furthermore, correlations between international bond risk premia have increased over time, indicating an increase in integration between markets.

Link al Paper


Paper: Prima de mercado mediante encuesta

Market Risk Premium Used in 2010 by Analysts and Companies: A Survey with 2,400 Answers


The average MRP used by analysts in the USA (5.1%) was similar to the one used by their colleagues in Europe (5.0%). But the average MRP used by companies in the USA (5.3%) was smaller than the one used by companies in Europe (5.7%), and UK (5.6%).

The dispersion of the MRP used was high, but lower than the one of the professors: the average range of MRP used by analysts (companies) for the same country was 5.7% (4.1%) and the average standard deviation was 1.7% (1.2%). These statistics were 7.4% and 2.4% for the professors.

The paper also shows the MRP used in more than 20 countries and the MRP used in 2009.

The paper also contains the references that analysts and companies use to justify their MRP, and comments from 89 respondents that illustrate the various interpretations of what is the required MRP.

Link al Paper


Mirando la zona Euro

Baseline tiene un interesante post que agrupa la problemática europea: deuda, deficits, riesgo moral, corrupción, rescate.

The eurozone self-rescue plan announced last night has three main elements:

  1. 750bn euros in a fiscal support program, with 1/3 coming from the IMF (although this was apparently news to the IMF).
  2. The European Central Bank promises to buy bonds in dysfunctional markets.
  3. Swap lines with the Federal Reserve, to provide dollars


The underlying problem in the euro zone is that Portugal, Ireland, Italy, Greece, and Spain are locked into a currency which means they are uncompetitive in trade terms while they are also running large budget deficits.  To get out of this they need large wage and price cuts to restore competitiveness, and they need to make fiscal cuts to get budget balances back at sustainable levels.

Markets decided these adjustments were going to be difficult, so spreads on those countries’ debts widened (i.e., interest rates relative to German government bonds).  As the rates go up, this causes local asset prices to fall, concerns over bank balance sheets increase, etc.  This combination was causing an incipient run on banks.  Any country with its own currency could reasonably devalue in such a situation, but this is not an option within the euro bloc.


To ultimately get out of this mess, the euro zone needs to grow fast enough to allow nations to grow out of debt.  The global backdrop here is very positive in the short term.  The jobs numbers in the US last week and strong numbers out of core northern Europe suggest the world can grow.  No doubt the ECB and the Fed will use the eurozone scare to justify longer loose policies.

It could be that in two years time Europe’s deficits are much lower, the ECB has hardly bought any bonds, and they have successfully managed a Greek debt restructuring while Spain is out of trouble, and Portugal and Ireland are scraping by in limbo but now isolated problems.  With the US likely to still be running near 10% GDP budget deficits – who will seem more risky then?  This immediate confidence in the US dollar that has come out of this European crisis could very quickly evaporate.

Alternatively, the underlying fiscal problems in Europe could fester – and the “rules” designed to limit moral hazard may turn out to be a complete paper tiger.  In that case, the Europeans again have to make a fateful decision: Do they try to inflate out of the debt burdens of their weakest member countries; or do they instead try to manage selective default, keeping in mind that most Greek debt at that stage will be held by other eurozone governments.


Paper: Temores y Riesgos

Tails, Fears and Risk Premia

We show that the compensation for rare events accounts for a large fraction of the average equity and variance risk premia. Exploiting the special structure of the jump tails and the pricing thereof we identify and estimate a new Investor Fears index. The index suggests both large and time-varying compensations for fears of disasters. Our empirical investigations are essentially model-free, involving new extreme value theory approximations and high-frequency intraday data for estimating the expected jump tails under the statistical probability measure, and short maturity out-of-the money options and new model-free implied variation measures for estimating the corresponding risk neutral expectations.

Link al Paper


Paper: Implied Volatility y Risk Premia

Option Implied Volatility Factors and the Cross-Section of Market Risk Premia

The main goal of this paper is to study market volatility risk premia. I develop a multifactor model by proposing a pricing kernel, where the market return, the diffusion volatility and the jump volatility are fundamental factors that change the investment opportunity set. Based on estimates of the diffusion and jump volatility factors using S&P500 index returns, options and VIX, the paper finds negative market prices of volatility factors in the cross-section of stock returns. The findings are consistent with risk-based interpretations of the value and size premia and indicate that the value effect is mainly related to the diffusion volatility factor, whereas the size effect is associated to both the diffusion and jump volatility factors. The paper also finds that using market index data alone may yield counter-factual results.

Link al Paper


Paper: Equity Risk y Treasuries

Equity Risk and Treasury Bond Pricing

We show that changes in equity risk are substantially tied to changes in the slope of the Treasury term structure over the recent 1997 to 2007 period, even after controlling for Treasury-market state variables and contemporaneous bond-market variables suggested by the literature. Risk is measured by the implied volatility from equity-index options and 10-year T-Note futures options. We find a partial negative relation between monthly changes in equity risk and monthly changes in the term-structure’s slope, as measured both by the term-structure’s second principal component and the term yield spread. Further, equity risk contains reliable forward-looking information about the volatility of the unexplained change in the term-structure’s slope. Our evidence suggests that equity risk changes are reliably tied to changes in the spread between equity and T-bond risk premia and that changes in equity risk can be important for understanding movements in the Treasury term structure.

Link al Paper

Fun & Finance


Fun & Finance Rollover

"It is hard to be finite upon an infinite subject, and all subjects are infinite." Herman Melville

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