A Decomposition of Conditional Risk Premia and Implications for Representative Agent Models
177 Pages Posted: 1 Dec 2020 Last revised: 29 Jun 2021
Date Written: June 28, 2021
We develop a methodology to decompose the conditional market risk premium and risk premia on higher-order moments of excess market returns into components related to contingent claims on down, up, and moderate market returns. The decompositions do not depend on assumptions about investor preferences, nor do they depend on assumptions about the market return distribution. Analogous decompositions implied by prominent representative agent models fail to match those implied by the data. Our results provide a host of new empirical facts regarding sources of conditional risk premia and identify a set of new challenges for representative agent models.
Keywords: Market risk premium; Variance risk premium; Crash risk; Conditioning information; Risk-neutral moments; Preferences; Stochastic Discount Factor
JEL Classification: E44; G1; G12; G13
Suggested Citation: Suggested Citation