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Risk Premia and Variance Bounds

Pierluigi Balduzzi and Hedi Kallal

Journal of Finance, 1997, vol. 52, issue 5, 1913-49

Abstract: If a pricing kernel assigns a premium to a risk variable that differs from the one assigned by the minimum-variance admissible kernel, then the pricing kernel must exhibit more variability than the minimum-variance kernel. Based on this intuition, the authors derive a variance bound that is more stringent than that of Lars Peter Hansen and Ravi Jagannathan (1991). When the authors apply their bound to the kernel of a representative consumer with power utility, they find that the consumption risk premium increases the severity of the 'equity-premium puzzle' of Rajnish Mehra and Edward C. Prescott (1985). Copyright 1997 by American Finance Association.

Date: 1997
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Handle: RePEc:bla:jfinan:v:52:y:1997:i:5:p:1913-49