What is Risk Premium?

Risk premium (Risk premium) is that investors face different levels of risk, and are aware of the high risk, high return, low risk and low return. Because investors' tolerance for risk affects whether they want to take risks and get High remuneration, or accept only the benefits that have been determined, and give up the higher rewards that you might get. The difference between the determined return and the return from risk-taking is the risk premium. It is the compensation that investors demand for their own risks.

Risk premium

Financial risk premium

Financially compare the return of a risky investment vehicle with

background

Two different meanings of "risk premium" It should be noted that the term "risk premium" has two different meanings: one is ex-post or realized risk premium, which is actual and historical Data Observed Market

First, the equity risk premium is an illusion. The empirical data is wrong. The problem is not caused by the asset pricing model based on consumption, but by the empirical estimation of the Sharpe ratio. Historical data overestimates the actual risk premium. .

Second, high risk aversion means that investors are more risk averse than economists estimate. If the correlation coefficient of risk aversion is 100, then the mystery of risk premium will no longer exist.

Third, the non-standard utility function. The standard asset pricing model based on consumption is based on the assumption that the utility of each period depends only on the current consumption. However, this assumption oversimplifies the model. In order to make the model more realistic, economists recommend using a non-standard utility function, but Cochrane (1997) believes that there is no such low-risk model that can make equity risk premium, real interest rate stability, and almost unpredictable. Consumption growth rate has remained consistent.

Fourth, the difference between investors. In traditional economic analysis, we generally assume that the typical investor, that is, the future investment income of securities, all investors have the same investment philosophy, and the investor's utility function is the same. The market is also priced by investors exactly the same. This assumption obliterates the differences between investors, including: educational background, amount of funds, investor mentality and other factors. The assumption that investors have no difference is not in line with reality. Perhaps it is the differences between investors that have caused excessive equity risk premiums.